Going by prevailing business trends in Cummins' low horse power generators overseas shipments, exports would all but flatten this fiscal with domestic industrial markets resiliently thronging order flows - growth in domestic industrial business revenues contributed nearly 50% to rise in total revenues last fiscal. GOI's renewed thrust on road infrastructure burnished demand for its 6 cylinder and 4 cylinder engines powering excavators and road machinery equipments. Indian Railways focus on gauge conversion - propels demand for track maintenance machines - and increasing last mile connectivity also helped gain market share in DEMU applications last fiscal. Effectual partnership with global OEMs to address market demand in Japan, China, South Korea and Canada enhanced its market positioning in off-highway market.
Ebullience in Cummins' prized export markets for once flourishing low horse power generators seems to have subsided (sales down nearly 18% last fiscal), all thanks economic slowdown in some of its key markets in Middle East, Africa, Europe and Asia, thus astonishingly reversing its strong growth trajectory seen in FY15 when its shipments nearly doubled. Given the prevailing stress in these largely commodity dependent markets, low LHP generator segment appears not to have scraped the bottom yet. Still Cummins posits increased off take in demand for its high horse power generator market this fiscal.
Distraught with no puny challenges - be it entrenched market resistance to price rises post implementation of CPCB-II norms to higher domestic competition from global players to more conspicuous reducing power deficit in the country - Cummins domestic power gen business showed no little traction last fiscal - grown by some 8%. Rising urbanization has catapulted back up power demand has helped congregate orders from hospitality, commercial realty, data centers and IT & ITES. Order flows would gain momentum from multitude of compelling initiatives: fleet expansion and modernization of Indian naval fleet to spur marine propulsion and diesel genset market; city gas distribution compressor market to gain traction; higher tonnage equipment market to benefit from higher coal production.
After slowing down for a couple of years starting FY14 when weak economic growth coupled with reduced engine utilization by key power generation customers, Cummins distribution business has now spring to life for it grew by some 7% last fiscal. Hectic domestic industrial and off-highway activity - infrastructure, marine, railways etc - explain much of the sumptuousness in revenue booking, partly triggering the expansion of operations at its India Parts Distribution Center (IPDC) at the Megasite. Yet reducing domestic power deficit would doubtlessly impinge demand for after-market parts & services in generator set applications, making prospect of sharp jump in revenue recognition more elusive.
The stock currently trades at 31.7x FY18e EPS of Rs 29.37 and 27.5x FY19e EPS of Rs 33.80. Relegation of its return on capital and asset turnover ratios over the years - ROE pummeled from 35.1% in FY11 to 22.1% last fiscal; fixed asset turnover nosedived from 12.4 to 3.6 - is the fallout of mighty investments in much hailed India office campus - pre-tax returns on investment property struggling to race past 5%, wretched yields on its stock of liquid funds and somber investment environment. Its stock of gross fixed assets last fiscal (save over Rs 400 crs investments in Technical Center which would get capitalized this fiscal ) has grown nearly thrice as much as that in FY11, while its revenues barely rose by a quarter. Reliable recovery in its export market is patently some quarters away. Yet cost optimization resulting from initiatives like six sigma, accelerated cost efficiency and closure of PMUC operations has played well. On balance we maintain our 'reduce' rating on the stock with revised target of Rs 811 (previous target: Rs 645) based on 24x FY19e earnings (peg ratio: ~2) over a period of 9-12 months.
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