Cummins India's margins face pressure

Analysts say lower realisations could be due to decline in exports

Every stock pays a price for not meeting the Street’s earnings estimate and the penalty gets steeper with a dismal trading session. The stock of Cummins India fell by around five per cent on Tuesday, as its December 2015 quarter (Q3 FY16) results failed to keep up with analysts' estimates.

Though revenues at Rs 1,147 crore inched up six per cent year-on-year (y-o-y), operating expenses grew faster (nine per cent) and consequently operating profit in Q3’FY16 declined by nine per cent y-o-y. Ruchir Khare of Kotak Securities says the advantage of benign raw material prices is yet to be seen in Cummins’ financials. Despite a near 25 per cent fall in input prices, raw material costs softened by only two per cent y-o-y, indicating that higher import content could have offset the benefit of lower raw material costs.

  Operating profit margins, thus, came at about 15 per cent (down 170 basis points, or bps, y-o-y) and were lower than estimates of 17 per cent. Analysts attribute the lower realisations to a decline in exports and unfavourable product mix—a factor that has weighed on Cummins’ profitability for four to five quarters. The share of exports, which stood at 40-45 per cent of revenues until Q1 FY16, fell to 38 per cent in the September 2015 quarter. Export sales may have been under pressure in Q3 FY16 as well, given weakening telecom orders from Africa.

That said, revenue growth for the quarter was largely guided by a 12-per cent growth in the domestic market, led by segments such as power generation and distribution. However, revenues in these segments are mostly from low-horse power generation sets, where realisations are relatively lower.

On the whole, even as other income at Rs 56.6 crore rose by around 37 per cent y-o-y in Q3 FY16, net profit at Rs 178 crore declined by about two per cent y-o-y and came in lower than the Bloomberg consensus estimate of Rs 190 crore.

At present, 21 out of 43 analysts polled on Bloomberg have a buy recommendation on the stock. However, the management commentary, expected on Wednesday, would be critical as any downward revision in export targets or unimpressive domestic demand outlook could result in de-rating of the stock as profits have come under pressure in the past three quarters.

In terms of valuations, trading at 27 times FY17 price-earnings, the stock is trading at significant premium to the Sensex (17 times).