Shift to new norms may hamper growth, margins for Cummins India in FY24

Supply chain challenges and export demand are other concerns for the maker of engines and power equipment

Over the past three trading sessions, the stock of Cummins India has gained about nine per cent on strong January-March quarter (Q4) results and good near-term prospects. Its Q4 performance was led by a healthy 29 per cent revenue growth over the year ago quarter. This was largely on the back of a 33 per cent jump in domestic revenues while exports witnessed a growth of 17 per cent.

Domestic sales, which accounted for 74 per cent of the company’s revenues in the quarter, were aided by pre-bookings prior to the new norms of Central Pollution Control Board (CPCB) that come into effect on July 1.

While all segments did well, growth was higher in the power generation and distribution segments, which reported a 43 per cent and 31 per cent surge, respectively, due to higher volumes from data centres, pharma, real estate, hospitality and manufacturing. Demand in the construction segment recovered to pre-Covid levels. This, coupled with healthy traction in mining and railways, helped the industrial segment grow by 14 per cent.

The firm posted a better-than-expected expansion in gross and operating profit margins with the latter growing 310 basis points over the year-ago quarter to 16.9 per cent. Sequentially, however, gross margins contracted as sales mix was skewed towards low margin segments while there was a slower pick up in high margin segments such as exports, highlights JM Financial Research.

For the full year (FY23), the company said it posted record revenues and profits and this was driven by strong demand from domestic and exports coupled with pricing actions and prudent cost management. The company, however, is cautiously optimistic about the short- to medium-term outlook given the emission changes from July and continued supply chain challenges, especially for specific electronic and other components. It has thus refrained from giving guidance for FY24.

Say analysts led by Subhadip Mitra of Nuvama Research, “With no guidance for FY24, we find concerns on sales growth/margins from H2FY24 onwards, as new CPCB norms imply costlier products, with chip supply issues and limited pricing power.”

Nomura Research, too, believes that after boosting sales and profitability in the June quarter, volumes and gross margins in particular face a sharp squeeze from the second half of FY24, potentially lasting for the entire fiscal year.

Given that there is an overlap of lower priced CPCB II and CBCB IV product sales from July to December of this year, it will become tough to sell higher priced CPCB IV products at the same power ratings. (CPCB stands for Central Pollution Control Board; II & IV are a set of norms).

Priyankar Biswas and Neelotpal Sahu of Nomura Research say that in such circumstances, the 30-50 per cent price hikes proposed by management may be challenging, leading to gross margin contraction by 100 basis points year-on-year for FY24 to 30.3 per cent. About 80 per cent of the power generation segment sales (or 25 per cent of FY23 sales) would be impacted due to the norms which are applicable on sub-800kW products.

Antique Stock Broking, however, is positive on the company’s prospects going ahead. It believes that Cummins India can be a beneficiary of the domestic infrastructure capex cycle and CPCB norm changes. It can also benefit from revival in exports and play a vital role in the global supply chain of Cummins Inc. Further, the company is well placed to take advantage of business demand recovery, given its preparedness on the technology front and leadership position, say analysts led by Dhirendra Tiwari of the brokerage.

At the current price of Rs 1,745, the stock is trading at 34 times its FY25 earnings estimates. Given the recent rally and uncertainties regarding demand/margins in the second half of the year, investors should await stable trends before considering the stock.