We like steady growth, so we don’t follow many industrial companies in the Investor Advisory Service. Most are too cyclical to provide the compound returns we like to see. Occasionally we find an industrial stock with what looks like strong underlying growth trends and decide to follow along. In April 2012 we introduced readers to Cummins Inc. (Ticker: CMI), a manufacturer of diesel engines and components. Let’s take a look at what Cummins has done over the past twelve months.
Each month’s IAS begins with our “Investment Comments” section, in which we focus on the economic data we believe to be driving markets. We noted strengthening employment numbers in April 2012, a trend that has mostly continued throughout the past year. Auto sales were picking up. The Purchasing Managers Index pointed to some manufacturing growth.
If manufacturing continued to improve, Cummins could benefit. Engines are 52% of overall sales. Non-engine components are 18% of sales. Power Generation is 16%. Aftermarket distribution is 14%. We call Cummins a “growth cyclical.” The company has peaks and troughs, but measuring peak-to-peak or trough-to-trough, historical growth has been pretty good. With 2011 revenue of $18 billion and a market capitalization of $22 billion, Cummins is one of the larger companies we follow. More than half of Cummins’ business comes from overseas markets, 59% in 2011. Another attractive feature is that Cummins’ debt load is fairly nominal relative to its size. We modeled 13% earnings growth, with 11% revenue growth. Priced at $117 per share, we modeled a possible high price of 274 and a low of 76 over five years.
Results looked strong out of the gate, with 16% revenue growth in Q1 and a 36% EPS increase. The market turned negative on CMI shares, however, suggesting pessimism whether those growth figures could continue. Sales turned negative in Q2, down 4%, and underlying trends pointed to results being flat to down during the second half of 2012. After hitting a low of $82 in early July, shares rebounded above $100. We were a little surprised at the abruptness of the sales slowdown, but cyclical stocks can often gain or lose momentum rapidly and without much warning. Q3 came in well below projections, although the share price held up okay. Sales fell 11%, and EPS fell 21%.
The silver lining was that even in a pretty disastrous quarter, Cummins remained solidly profitable. When Q4 showed some slight improvement, shares even briefly rallied above our original recommendation price. At a recent price of $117 per share, plus a $2 annual dividend, Cummins has gained about 2%. That’s well behind the S&P 500’s roughly 15% gain over the same period, but cyclical stocks tend not to track closely with the overall market. The industrial sector has been a little bit sluggish, and if it picks up in 2013, Cummins will probably turn in good performance.
Disclaimer: This company was selected for review in part because of its performance over the past year. Any outperformance relative to the broader market is not necessarily indicative of performance of the broader Investor Advisory Service.