Cummins shares fall as one-offs hit margins

Cummins shares fall as one-offs hit margins

The December quarter performance of Cummins India Ltd has disappointed the market. December quarter operating profit margin was at 18%, registering a 480 basis points (bps) year-on-year (y-o-y) decline—almost twice that expected. One basis point is one-hundredth of a percentage point.

The large-cap stock reacted adversely and fell 5.3% to Rs649 after outperforming both the BSE-500 and capital goods indices on the Bombay Stock Exchange in the past four months.

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Market expectations had reigned high as the earlier three quarters saw sustained growth in profitability as a result of operational restructuring initiatives by the parent and improved product mix.

Operating profit margin (OPM) during the first half of fiscal 2011 had gone up by 140 bps over the year-ago period to 21%.

Margins fell in the December quarter partly due to higher commodity costs—steel and copper prices have jumped nearly 30% in the nine months of fiscal 2011. Even on a quarter-on-quarter (q-o-q) basis, OPM declined by about 180 bps.

But the December results were disappointing also because of a comparatively better year-before quarter due to one-off developments. A higher proportion of heavy-duty, high-margin product mix and lower wages paid due to a strike at that time led to lower costs and better margins in the year-before December quarter.

Consequently, operating profit for the quarter fell 5% to Rs180 crore even though net sales rose by around 20% to Rs992.5 crore. Net profit dropped 6% to Rs138.9 crore. Local sales are expected to be robust over the next 18-24 months given the potential for gensets. But analysts express short-term concerns due to rising commodity costs. Further, any slowdown in the capital goods sector could affect growth rates.

One big positive is its parent Cummins Inc.’s commitment to make India the global hub for outsourcing its heavy-duty engines and generator exports.

A Religare Securities Ltd report following the announcement of the parent company’s full year (December) 2010 results says, “Across India, Cummins Inc. intends to incur a capex of $300 million (Rs1,400 crore) in over three years to expand capacity (capex for JV included)." Meanwhile, reports suggest that the Indian entity has trebled its capex to Rs500 crore until fiscal 2012-13.

Hence, Cummins India’s revenue and profit boost would get a fillip through exports, which should account for one-third of revenue in the next 15-24 months. During the quarter, exports registered a 200% growth rate. For fiscal 2011, Cummins management has reiterated its revenue guidance of 45% y-o-y growth from Rs2,813 crore.

Analysts’ consensus is a likely 5% earnings downgrade for fiscal 2011 and 2012. The current market price discounts the 2012 earnings about 18 times implying reasonable valuations.

Of course, its relatively high return on capital employed and OPM compared with most peers due to its product profile, gives it an edge.

Graphic by Ahmed Raza Khan/Mint

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