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Cummins: An underperformer

Mar 29, 2004

While other engineering stocks have outperformed Sensex significantly over last one year, Cummins India, the largest manufacturer of diesel engines, has been an underperformer. As can be seen from the graph below, Rs 100 invested in Sensex last year would have appreciated to Rs 184 (Rs 179 in Cummins). Thought the magnitude is lower compared to the Sensex, when compares the stock with its peers, Cummins pales. Let's have a look at reasons for the same.

One of the main reasons for the same is that Cummins India reported lackluster results for 3QFY04 with the topline growing marginally by 1%. However, due to higher other income, the bottomline of the company grew by 10% YoY. Operating margins remained on the lower side (down 70 basis points).

(Rs m) 3QFY03 3QFY04 Change 9mFY03 9mFY04 Change
Net sales 2,221 2,244 1.0% 6,062 6,597 8.8%
Other income 162 211 29.8% 301 551 83.3%
Expenditure 2,006 2,041 1.8% 5,372 5,921 10.2%
Operating profit (EBDITA) 215 203 -5.8% 690 676 -2.0%
Operating profit margin (%) 9.7% 9.0%   11.4% 10.2%  
Interest 3 2 -22.9% 9 10 14.8%
Depreciation 64 81 26.2% 202 222 9.5%
Profit before tax 311 330 6.4% 779 995 27.7%
Tax 66 61 -7.4% 213 198 -6.7%
Profit after tax/(loss) 245 269 10.0% 567 797 40.7%
Net profit margin (%) 11.0% 12.0%   9.3% 12.1%  
No. of shares (m) 198.0 198.0   198.0 198.0  
Diluted earnings per share (Rs)* 4.9 5.4   3.8 5.4  
P/E ratio (x)         18.6  
(* annualised)            

Due to a 5% dip in domestic sales, the topline of the company has failed to impress. However exports have risen by 22%. Topline growth would have been negative but for this higher export sales. As per the company, the decline in domestic sales was due to supply chain difficulties that are likely to be resolved soon and is hopeful of achieving of 10% growth from domestic markets. Exports are likely to grow by 20% YoY, as Cummins International plans to outsource K50 engines from Indian subsidiary. The 9% growth in the topline for the nine-month period is due merger of two of its subsidiaries, Power Systems India Limited (PSIL) and Cummins Power Solutions Limited (CPSL), with Cummins India.

Growth in the other income was due to higher dividends received from the subsidiary companies (Rs 237 m this year as compared to Rs 111 m last year). In order to rationalize the cost, Cummins India is taking various steps like Turbokaizen and Six Sigma programs, which are likely to show a positive impact over longer term. However, due to sharp increase in metal and fuel prices, operating margins are on the lower side. Also, due to rupee appreciation, the pricing has remained under pressure for exports.

Increase in fuel price (especially diesel up 26%) remains a big cause of worry for its diesel engine business, as the cost of power generated increases significantly thus making it unfeasible for the industrial units. Going forward, the implementation of the Electricity Bill is likely to have a strong short term and long term impact on the industry. The provisions of the Bill will provide a fillip to captive generation, rural electrification and improvement in the overall electricity infrastructure in the country. Improved distribution performance in areas such as Delhi by private sector T&D ventures will see a reduction in load shedding and improved power supply. This is likely to hamper demand of diesel engines.

At the current price level of Rs 98, the stock trade at P/E multiple of 18.3x annualised 9mFY04 earnings. Though the company is taking aggressive steps to reduce costs, rising input costs are likely to keep margins under pressure going forward. Until a couple of years back, diesel was much cheaper than petrol. But since then, diesel prices have been steadily on the rise, thus making the use of diesel engines expensive. Considering all these factors, it seems that concerns outweigh the positives of the company.

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