01 September 2017 Investment-ideas

The Blues of Cummins India

Incorporated in 1962, Cummins India Limited (CIL) is the country's leading manufacturer of medium-high horsepower (HP) range of diesel and natural gas engines for power generation, industrial and automotive markets. The company has manufacturing facilities in Pune and Daman. CIL is a play on the multiple segments of power requirement, rising mobile penetration across rural and suburban geographies, strong coal requirement driving demand in mining, and continued growth in automobile sales on the back of large potential in environment friendly natural gas fuel-based engines. The company is a major outsourcing hub for its parent, especially in the LHP generators and high HP engines. CIL will benefit from growth in the above segments.

Cummins in India, a power leader, is a group of complementary business units that design, manufacture, distribute and service engines and related technologies, including fuel systems, air handling, filtration, emission solutions and electrical power generation systems. Its technology and pioneering initiatives are bringing innovative solutions and dependable services at the best possible value to users across the country. Its high-performance outlook is based on customer focus, integrity and capability of its people. Cummins in India is a group of eight legal entities across 200 locations in the country with a combined turnover of Rs 10,262 crore in 2015 and employing over 10,000 individuals.

For the April-June’17 quarter, the company missed the estimates owing to unfavorable product mix and increase in staff costs.

During the quarter, the company recognised exceptional item net of tax amounting to Rs 43.8 crore pertaining to gain on sale of its Viman Nagar property. The profit on sale was Rs 56.1 crore and the tax impact Rs 12.3 crore. The high other income at Rs 58.3 crore was offset by higher taxes of Rs 62.5 crore resulting in 8.4 per cent decline in APAT to Rs 170 crore.

Domestic Market

The 12 per cent YoY domestic revenue growth was commendable considering price cuts in response to competition. The revenue for domestic business is Rs 1,340 crore with power genset posting Rs 370 crore, distribution business recording Rs 340 crore. The industrial and excise segments witnessed Rs 200 crore and Rs 85 crore, respectively. The miscellaneous category posted loss of Rs 92 crore.

The recovery in the domestic market is expected to be driven by railways, construction and standby DG sets, which coupled with restocking in exports, should improve the company’s revenue mix going ahead.

The domestic market comprises of 70 per cent of the total revenues; any major slowdown in this market would pose a significant down side risk to the estimates.

Revenue

Confluence of 12 per cent growth in the domestic business and 3.1 per cent decline in exports led to revenue growth of 6.5 per cent YoY. CIL’s revenue mix was adversely impacted by weak exports (which seem to be improving now) and some competition, which it tried to counter with selective price cuts.

The management has maintained its revenue growth guidance of 5 to 10 per cent in the domestic business. The increase in crude prices and pickup in private capex in domestic geographies could provide an upside to the revenue estimates. Over the upcoming 2017-2020 period, consequently, the tepid revenue CAGR of 7.9 per cent is expected.

Margins

Gross margin was impacted 130bps YoY by revenue mix, which coupled with salary hikes dented EBITDA margin. The gross margins have reduced due to change in mix of products. The adverse sales mix and higher employee cost resulted in EBITDA margins declining 180bps to 14.6 per cent YoY.

The profitable products are seeing lower demand compared to last year and products that are less profitable are seeing higher demand. However, the company is considering this and trying to address the situation. The management expects to hold margin at current level and will try to increase it by 100-150 bps by the end of the year, which it will be able to achieve via cost efficiency.

The staff cost has increased where the average merit cycle was around eight per cent. However, by the end of the year it expects variable wages to employees increasing in 2018 compared to the last year with the run rate of employee cost to be Rs 100 crore for each quarter.

Exports

On quarter over quarter basis, the exports sector jumped 30 per cent though the segment declined five per cent YoY to Rs 400 crore on start of restocking which we believe is likely to improve further as demand normalises from channels. The exports in high horse power started to rebound in a smart way. It should start seeing an impact on the company and in the short term the upsides will not be evident.

The international geographies, such as Middle East and Africa, continue their declining demand trajectory on the back of liquidity issues and lower crude prices, which the company expects to improve going forward. The demand in these and other markets are flat and the management does not expect a pick up any time soon, it does not see any substantial change in demand. The Middle East and Africa markets impact 20 per cent of CIL’s export revenues and are resulting in a decline in these markets. A gradual pick up is expected led by higher demand from emerging countries coupled with rising mandate from parent. 

The total exports revenue stood at Rs 390 crore with high horsepower segment posting Rs 165 crore, Rs 110 crore contributed by mid-range followed by LHP and HD posting Rs 70 crore and Rs 30 crore, respectively, and spare parts section contributed Rs 25 crore. The US dollar-rupee exchange rate is pegged at 64.6 and if there are any substantial movements then it adjusts.

For fiscal 2018, the management expects flat five per cent downfall in exports with power genset to grow in the guidance range and industrials to grow above the guidance range as it is positive on the industrial business and will be able to grow it in double digits even though the compressor segment is still in a depressed state.

Industrial Segment

The industrial segment grew 18 per cent on year over year basis. The growth in this division was driven by strong growth and improved spending in construction and railways. The government’s thrust on infrastructure will continue to derive CIL’s industrial segment. With this thrust, the management remains confident of clocking double digit growth in the sector for the current financial year 2018.

The revenue for the division stood at Rs 20 crore with the construction business posting Rs 75 crore, followed by railways’ revenue at Rs 45 crore, compressors scored Rs 40 crore and both mining and miscellaneous categories with Rs 20 crore each.

Flattish Power Genset Segment

On year over year basis, the segment remains flat. The demand from hospitality, healthcare and retail malls continues to ride growth in high horse power (HHP) and medium horse power (MHP) at 12 and 20 per cent, respectively, in the domestic market. Cummins’ focus is on the high horse power with more than 500 kilovolts (kv). Realty has also buoyed demand for HHP gensets. Intensified competition coupled with an improving power scenario continues to act as headwinds in the domestic powergen market.

Revenue for the sector is Rs 370 crore. The maximum revenue is contributed by the HHP with Rs 185 crore followed by mid-range with Rs 120 crore and with low kVa category contributing Rs 40 crore and heavy duty with Rs 20 crore. The revenues for power gen division are expected to ramp up driven by improving demand from commercial real estate and data center and improved infrastructure spending. The mid-range gensets depend on the infrastructure for roads to benefit generator sales

The sales for HHP genset category have seen high price competition in general where the competitors were cutting prices to which CIL had to respond. The management stated that while it has selectively cut prices of some products and increased them in others, there has been no impact of the same on profitability.

Exited Automotive Business

Cummins has exited the automation business, with one large customer facing financial issues and another shifting to in-house development post the implementation of Bharat Stage (BS) - VI.

The company is out of the auto segment as it used to sell to an original equipment manufacturer (OEM), which now has some financial issues and to Volvo Eicher which has now decided to use its own engines.

Railways, Distribution and Others

The Railways electrifying is good for Cummins as it supplies railway sets that are used for electricity generation.

The distribution business is to grow at 15 to 20 per cent levels against the ten per cent historical levels. The growth will be driven by rising share of industrial business.

Capex expansion and Tax rate

The technology unit is almost ready and will be operational by October’17. Out of the total expenditure of Rs 500 to 600 crore, the impact for fiscal 2018 will be Rs 170 crore.

During the quarter, the increase in tax rate was due to two reasons: lower sales in exports compared to previous quarters. Hence, less exports tax benefits; research and development (R&D) tax deduction currently is 150 per cent

Manufacturing versus Outsourcing

Cummins has a strong co-relation to Index of Industrial Production (IIP) growth and commercial capex which imparts confidence for an improved growth rate from fiscal 2018. CILs Phaltan mega-site is now a sole manufacturer of small kilowatts gensets for global market. This will add peak sales potential of Rs 1200 to 1400 crore for CIL over the next two to three years.

The total 6,300 units were sold by the company, of which 2,500 units of LHP and 2,000 units of mid-range engines are outsourced by the company and are bought by CIL from Tata Cummins and Simpsons. The make component is not likely to be higher going forward. Earlier, the company had bought engines from Tata Cummins and Simpsons and brought them to Phaltan site where it did value addition. This has now been outsourced to Tata Cummins and Simpsons.

CIL does not have any plan to outsource K-19 engine manufacturing and will continue to manufacture it at its Kothrud factory in Pune. However, the company will be appraising the products as in improvising on the designing in such a way that it is able to make more revenue out of the same resources used and thus improve margin.

Key value triggers going ahead: Growth engine

CIL is currently treading carefully considering the heightened competition and muted exports outlook. The company is well positioned to leverage on solid domestic prospects which will be a key earnings driver over two to three years. With headwinds for growth, a meaningful upside is not expected in the short term. The healthcare and retail segments will see good demand.

The management’s cost focus, improving infrastructure, and after sales outlook coupled with quarter over quarter pick up in restocking in exports, will help the company post a better bottom line over the next few quarters. It is one of the preferred industrial names given potential for strong scalability in return on capital employed (RoCE) and return on equity (RoE) over the next two to three years as domestic demand improves, apart from better cash flow to profit conversion at 70 per cent.

The company is trying to work around several issues such as rising domestic competition, with its peers sharpening focus on larger engines and weaker exports outlook. The potential triggers are tightening emission norms and potential for a strong demand recovery in the domestic market, which over three to five years could propel CIL’s utilisation levels materially, driving cash flow as well as profitability. In addition to this, the company has done much better with rising production mandates from parent over the last two to four years, which reflects the latter’s higher confidence in CIL.

 

neha.seth@outlookindia.com

 

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TAGS: business, markets, revenue, growth, tax, Cummins India
OUTLOOK 01 September 2017