Monday, November 2, 2015

Update Cummins Inc

On October 27 Cummins reported Q3 results. The big issues were noted in the company's foreign markets. Most notably Brazil and China. No doubt these two economies had been struggling based off recent headlines so it was only a matter of time before it showed up in the results. On the bright side North American sales continued hold up.  I think when the cycle reverses Cummins will be nicely positioned overseas to capitalize on economic improvements. I think management was keen to get most of the bad news out of the way now instead of letting it slowly leak out over the next few months.

The company reported EPS of 2.14/share coupled with a move to cut up to 2,000 jobs. While I never like to see a company layoff workers it appears from the conference call the job cuts will not be isolated to one segment of the business. The company noted it will be making a lot of corporate job cuts(think selling and administrative), and looking at ways to reduce manufacturing head count.  Nothing was mentioned specifically about the engineering or R&D departments so it seems any damage to this area will be light. Cummins Inc has built a distinct technology advantage over its competitors. It was noted on the call that the company had no intentions of relinquishing that lead leaving it to compete more on price. Anyway I applaud management for taking a quick approach to cut costs and re-align based upon market conditions.

Management stated they don't believe a bottom is in yet in many of their markets. They previously thought they had already reached a bottom but were proven to be incorrect. There is obviously the potential for more downside in the business, but management had already noted its intention for forecasting no improvements for 2016. Assuming they are correct and business stays the exact same we can reach a couple of conclusions. First lets assume the dividend is frozen at $3.90/share. Also for the last 12 months the company has earned $9.46/share.  This would give us total earnings power per share of $13.36 for a total yield of 13.1%(13.36/102 share price).  If the business doesn't deteriorate any further we can reasonably expect our investment to earn us 13% on our money for the next year. If earnings go down to $8.50/share we can expect a total yield of 12.1%.  If EPS were to drop that much the shares would likely follow suit allowing an opportunity to buy shares even cheaper.  Additionally management seemed confident in the company cash flow prospects. There appears to be no plans to curtail stock buybacks, and I would expect another dividend increase in 2016 albeit at a much lower percentage increase compared to recent history.  As of now CMI yields 3.8%, and if we factor in an increase of 10% to the dividend(estimated $4.25-4.30/share) for next year that would give investors a yield of 4.1% for 2016 if the stock were at $102. That definitely makes the stock a friendly dividend pick to get paid while we wait for the business to turn around.

On a technical note when I take a look at a weekly chart the stock is near oversold levels. This makes the contrarian side of me believe the stock could be due for a short term bounce. So if you want to start a position I wouldn't go chasing the stock.  I'd make sure to keep buys below $110/share.

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