Cummins: Strong domestic growth not enough to sustain investor interest

While the management has guided for 10-15 per cent growth in India business, exports may stay on a weak footing

For investors of Cummins India, a subsidiary of US-based Cummins Inc, the lack of predictability in overall growth is a concern. While the engine manufacturer has remained positive on domestic growth, exports, which account for over 30 per cent of its overall revenue, have remained the paint point for many quarters.

Exports are important, not just in terms of revenues, but also profitability. While India is not a key market for high-end products, overseas markets like Europe, Middle East and Africa are consumers of heavy-duty motors. Therefore, to scale up profitability, the higher-margin export volumes are crucial.

FY19 was expected to be better than earlier fiscals on domestic and overseas parameters. However, the disappointment from exports was felt more in the March quarter (Q4). While revenues grew by 9 per cent year-on-year to Rs 1,340 crore, that wasn’t enough. Net profit shrank by 13 per cent year-on-year to Rs 141 crore – also the weakest in recent times. As volumes were largely pumped up by low horse power (LHP) engines, nearly tripling year-on-year due to strong domestic demand, the key heavy duty segment saw a 67 per cent decline in volumes, thereby dragging operating margins down by 121 basis points (bps) year-on-year to 12.8 per cent in Q4.

Cummins closed FY19 with 15.3 per cent margins (up 11 basis points year-on-year), but the weak management guidance on exports mean that FY20 margins could be capped at current levels or possibly show a dowanward trend, unless exports post a surprise. Therefore, even if the 10 – 15 per cent domestic growth is positive, revenue growth and profitability will depend on the domestic product mix.

Analysts at ICICI Securities expect the domestic market to witness gradual revival in demand, driven by data centres (where Cummins India holds the highest market share) along with infrastructure, railways and manufacturing growth. With a 3 - 5 per cent price hike undertaken in FY19, a strong demand from these pockets could support profitability at current levels.

The good news is that despite a challenging environment, Cummins has maintained leadership in India with a market share of over 40 per cent. Yet, at 24x FY20 estimated earnings, the Street isn’t too positive on the stock given the expected pressure on near-term earnings. Analysts at JM Financial Research have cut their earnings target for FY19-21 by 10 per cent, operating margin estimates by 50 – 100 bps to accommodate an unfavourable product mix.