Formed in 1962, Cummins is India’s leading manufacturer of diesel and natural gas engines. The company operates through three business segments – Power generation, Distribution, and Industrials catering to both domestic and international markets. Domestic sales contribute 83% to total, while exports make up 17%. Within the domestic segment, power generation accounted for 43%, distribution constituted 35%, industrials contributed 20% and the remaining 2% came from other sources. In the export market, high horsepower (HHP) engines made up 45%, low horsepower (LHP) generated 44% of sales and the rest 11% came from other sources.

India’s economic expansion to fuel domestic growth

India remains resilient and is expected to outperform other large economies. The Reserve Bank of India (RBI) recently indicated it expects India’s FY25 GDP to grow at 6.8% YoY and FY26 by 6.6%, signalling strong prospects for the Indian economy. Additionally, in FY24 (ending March 2024), India’s private capital expenditure (capex) increased c.20% YoY, while public capex grew around 28% YoY. Given the country’s continued focus on infrastructure spending and a rise in corporate and financial sector capital utilisation to an 11-year high of 76.5% in FY24, both private and public expenditures are expected to remain healthy in the next few years.

In 2QFY25, Cummins reported a 47% YoY increase in domestic sales to INR20bn driven by good performance across domestic market segments. Within the domestic market, power generation revenue grew a robust 84% YoY, industrial revenue edged up 35% YoY, while distribution segment increased 20% YoY. The growth in the power generation segment was primarily driven by Central Pollution Control Board (CPCB IV+) transition. Meanwhile, Industrial segment growth was the outcome of higher construction activities and pre-buying, due to change in emission norms. The company expects this positive trend in domestic markets to continue in 2HFY25 and projects double-digit sales growth in full year FY25. Additionally, Cummins remains quite optimistic about its long-term demand recovery.

Recovery in global markets can prop up near-term exports

Cummins reported a 13% YoY decrease in exports to INR4.4bn in 2QFY25. HHP exports declined 24% YoY to INR2.0bn, while LHP exports slid 5% YoY to INR1.98bn. The decline in exports was primarily to a slowdown in global markets driven by economic and geopolitical uncertainties. However, there was a noticeable improvement in quarterly trends, with HHP sales increasing by 1% quarter-over-quarter (QoQ) and LHP sales rising by 28% QoQ. This marks the fourth consecutive quarterly improvement. This improvement was mainly driven by demand recovery in the Latin America and Europe while the demand from the Middle East, Asia pacific and African markets remained muted.

Cummins anticipates that challenges, such as supply chain issues and geopolitical risks, would persist in the near term. Hence, it remains cautiously optimistic about demand recovery in exports markets in the short term.

Consistent positive free cash flow helped reduce debt

Cummins consistently generated positive free cash flow (FCF) over the past five years, resulting in significant deleveraging. Debt fell 75% to INR1.3bn at end-FY24 from INR5.1bn at end-FY20. Consequently, debt-to-equity ratio improved to 1.9% in FY24 from 11.6% in FY20. Additionally, cash and short-term investments nearly doubled during this period, increased to INR26.9bn from INR13.8bn. Consensus estimates FCF to net income conversion rate to remain around 70% over the next few years (in line with the five-year average), indicating continued confidence in the company’s strong financials.

Attractive valuation compared to its local peers

The company has delivered consistent performance over the years, registering consolidated revenue CAGR of 27.3% over the last three years to reach INR90bn. During the same period, EBITDA has doubled reaching INR19.57bn, growing at 36.6% CAGR, and margins expanded by over 500 basis points (bps) to 20% in FY24. Additionally, EPS reached INR60, clocking CAGR of 39.4%. Forward estimates indicate continued confidence among analysts, with consensus anticipating Cummins to register revenue CAGR of over 15% for the next three years. Analysts expect EBITDA to reach INR26.85bn by FY27, with stable EBITDA margins of 19%.

Additionally, Cummins valuation looks attractive as compared to Siemens and ABB. Cummins is currently trading at a P/E ratio of 52.0x (based on FY25 EPS of INR66), as compared to Siemens 86.8x and ABB’s 87.5x. However, valuation looks stretched as compared to its 10-year historical average P/E of 33.5x and global peer average of 22.9x. Furthermore, on EV/EBITDA multiple, it is currently trading at 47.5x (based on FY25 EBITDA of INR19.76bn), compared to Siemens 90.0x and ABB 68.9x. On historical basis EV/EBITDA is trading higher compared to its 10-year historical average of 33.0x.

Overall, the company presents a compelling investment case, with CPCB IV+ transition ramping up, healthy macroeconomic growth in India and an expected recovery in global markets. While the outlook is positive, there are potential risks that could impact the company’s fundamentals in the near term. Prolonged slowdown in global markets, deceleration in domestic market growth and aggressive competitive pricing of CPCB IV+ products could significantly squeeze sales growth and profitability, especially amid rising commodity prices.