Thursday, September 8, 2016

Will Cummins Rule The Road?

I tweeted the other day the announcement regarding a partnership between Volkswagen(VLKAY) and Navistar(NAV) joining forces.  The partnership involves VW making a $256 million equity investment in Navistar for a 16.6% stake and two board seats.

The idea of the partnership is to allow sharing of engine technology, part sourcing, and other forms of collaboration between the two companies. The move gives Volkswagen better access to the profitable North American market through it's two European brands(MAN & Scania) where it's weak.

This is a big hit to Cummin's
since they have been supplying plenty of engines to Navistar for their North American operations. That was largely the result of Navistar engines not meeting strict environmental regulations. At one point Navistar was paying hefty fines for it's non-compliant engines. No worries I'm sure the fine money was put to good use by regulators.

This new partnership most likely means that in the near future their reliance on Cummin's engines will wane. The other hangover on Cummin's stock right now is the fact that other truck manufacturers have been trying to boost their in house technology to better align their cost structure with vertical integration.

The hit to their engine segment profitability is what concerns investors. The engine segment is the company's largest profit generator representing 38.6% of 2015's EBIT, and 35% in Q2.  It doesn't help that engine demand has been slowing worldwide the last few years. Although many are hoping the next year will put the roughest part of this downturn behind us. Eventually older trucks need to be replaced. The key is how many CMI engines will make it into those new trucks. It will take a few years for Navistar to lessen it's reliance on CMI trucks. Also at that point the truck cycle should begin to recover barring any massive dropout in the worldwide economy

This is all obviously a concern.  The thing is Cummin's has some of the best technology in the industry, and it's engines are often sought after from trucking customers.  The company has stated it's still committed to R&D and providing the best technology to customers.  Although it looks like this year R&D will come in lower than 2015(maybe $625mil), but that's expected given the decrease in sales as the company aligns costs.

I don't think the company will relinquish it's technological edge anytime soon.  As long as the company continues to make it nearly painless to insert one of their superior engines into any manufacturers truck I think we can expect them to keep ruling the road.  That doesn't mean the road will be easy.  I think the solid dividend will keep patient investors well rewarded as management navigates this rough terrain.  

I'm staying the course with this time tested engine champion.  I don't see this as a reason to sell. The company is well positioned to weather this downturn.  If things were to get worse then maybe I'd consider that. Besides I feel I wouldn't be The Long Haul Investor if I didn't own the King of Long Haul Truck Engines.

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