Weak demand, margin pressure set to worsen for Cummins India; stock falls

New emission norms to further add to demand challenges

Weak demand and competitive pressure, both in the domestic and export markets, have been weighing on Cummins India’s performance. This has led to a 25 per cent fall in its stock over the last three months. 

In fact, the slowing pace of growth had prompted the firm — a major player in medium-to-high horsepower range of diesel engines — to cut its FY20 growth estimates. 

For its domestic business, it has guided for 8-10 per cent growth (from 10-15 per cent earlier). The export situation has worsened, leading to a guidance of 12-15 per cent decline, against the flat-to-marginal decline earlier. 

While the company has been launching new products and gaining market share, there has been no let-up in competitive pressure.

Priyankar Biswas and Neelotpal Sahu of Nomura highlight that competition and pricing pressure have intensified since FY15. 

They believe new emission norms and a rise in costs in the low-horsepower range of products will result in margin pressure, even as the demand environment remains weak.

With the introduction of new emission norms, the firm had expected competitive pressure to reduce, which did not happen. Pressure on profitability has also been highlighted by Kotak Institutional Equities. Analysts at the firm have cut their price-to-earnings multiple from 20x to 19x, to incorporate the risk to margins over the medium term. 

They expect the margin differential between domestic and exports businesses to converge. “Our assessment of recent developments suggests competitive intensity is increasing for exports. There is risk to the 25 per cent operating profit margin that Cummins earns on exports, in the scenario of the weak demand environment,” Aditya Mongia and Teena Virmani of Kotak Institutional Equities said in a recent note. 

They believe that even in the domestic business, margins declined to 10 per cent levels from double the number over the last decade, due to intense competition. 

The share of exports has reduced in recent quarters, weighing on overall margins. In fact lower share of exports (25 per cent in the June quarter against 33 per cent last year), and impact of forex, resulted in the lowest operating profit margins (11.3 per cent) in a decade.

  

Despite the correction, analysts are negative as the key driver of the stock (margins) is unlikely to improve for the next couple of quarters.