Structural headwinds may lead to more downsides for Cummins India

Up to 45 per cent of its revenues at risk due to new draft policy

The Cummins India stock has been under pressure over the last months, shedding 12 per cent, on worries that the draft electricity Bill, which focuses on uninterrupted power supply and bringing down the use of diesel gensets (DGs), could risk about 40-45 per cent of revenues.
 
Though no impact is expected in the near term, the move to cleaner fuels/renewables will shrink the firm’s addressable market.
 
The Draft Electricity (Right of Consumers) Amendment Rules 2021 is at an early stage, but it highlights the government’s intention of reducing emissions. “In view of the increasing pollution level particularly in the metros and large cities, the Distribution Licensee shall ensure 24x7 uninterrupted power supply to all the consumers, so that there is no requirement of running the diesel generating sets,” says the draft.
 
With the policy asking consumers to shift to renewables over the next five years and temporary power connections for construction site users within 48 hours to reduce DG usage, there could be a secular decline for suppliers of DGs such as Cummins India.
 
Say Priyankar Biswas and Neelotpal Sahu of Nomura Research, “The draft electricity rules reinforce our view of structural challenges to diesel-based power; challenges emerge for diesel gensets and engines in back-up power and construction in addition to existing headwinds on Railways.”
 
The Railways, too, is gradually phasing out diesel engines on its broad gauge routes and shifting to electric locomotives. Though this is a structural shift, there might be limited impact in the near term due to the draft Bill.

Analysts at Motilal Oswal Research say no material impact is expected in the near term. However, this does take away a portion of the addressable market in metros and prospective customers over the medium term.
 
Some brokerages, believe the impact might be lower than expected thanks to lower emissions going ahead. One reason for this is the shift to newer standards such as CPCB IV+ to be implemented by July 2023. It requires a shift to electronic engine platforms and use of selective catalytic reduction. This will reduce pollution levels (particulate matter, nitrous oxide) from 2-6 per cent to below 1 per cent, according to Kotak Institutional Equities.
 
The brokerage also highlights that genset sales of Cummins grew at a healthy 12 per cent in North America between FY14-19, reflecting their relevance as an insurance against grid failure.

Technology development by Cummins’ global parent is another reason that analysts believe will make the firm better placed than others during both the transition to the new pollution norms and the shift to cleaner fuels.
 
Say analysts at IIFL Securities, “While the five-year suggested timeline (shift from DG sets to cleaner energy sources) is unrealistic, directionally, it opens the market for hybrid and hydrogen-based solutions, where Cummins is heavily invested.”    
 
Improving power supply would be a negative for the company, but analysts at Motilal Oswal Research believe it is a potential exports story, though the upsides on this count are better captured in the unlisted entity of the parent company. The company fails to impress as a proxy to domestic capex, they add.
 
The recent correction has taken the stock to price levels prevailing two months ago. Investors should await clarity on the draft Bill as well the pace of the company’s shift to cleaner energy solutions.