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Easing inflation, supply chain constraints to drive margins

Cummins India (KKC) 2Q23 numbers reported a strong beat on estimates. Net sales increased by 13% YoY (8% above JMFe), led by 11% growth in domestic and 21% growth in exports. EBITDA grew by 12% YoY (20% above JMFe), as strong sales growth and operating leverage benefits led to margins of 14.9% (+220bps QoQ) vs JMFe: 13.4%. With healthy balance sheet (no NWC build up seen) and higher other income (+23%), net profit grew by 15% YoY, 20% above JMFe. Management outlined that India growth should be around parent’s guidance of 20%, where domestic growth trends looks strong, but uncertainty persists in exports due to volatility in inflation and forex. We expect Cummins to deliver a robust CAGR of 16%/20% in sales/EBITDA led by strong volume growth in both domestic and exports market with further ease in supply chain. Gross margins to revert back to levels of 35-36% through sustained price hikes, new product launches in export markets and market share gains post CPCB-4 implementation as we believe Cummins India will have an edge over competitors. We maintain BUY with revised SOTP based TP of INR 1,500, implying PE multiple of 32x Mar’25E EPS, as we roll forward by 6 months.

*Healthy demand in domestic and exports drives beat: Net sales were up 13% YoY to INR19.5bn. During the quarter, engine segment reported growth of 13% YoY/16% QoQ, on the back of project income booked in data centre space (estimated at INR1bn); exports witnessed strong growth of 21% YoY. Power Gen and Distribution posted growth of 6% and 22% respectively, as volumes were robust from data centres, pharma & biotechnology and manufacturing, while utilisation of mining equipment improved. Industrial segment reported a growth of 10%, as growth in key segments of construction and railways (2/3rd of industrial) is not full recovered yet. Exports continue to clock robust growth of 21% YoY, led by LHP (+20% YoY), while HHP exports declined by 3% YoY.

* Gross margins could 300-400bps improvement in 18-24 months: EBITDA grew by 12% YoY to INR2.9bn (20% above JMFe), as margins expanded by 220bps sequentially. This was driven by easing RM inflation and operative leverage due to high project income. With easing supply chain constraints and declining RM prices, we expect operating margins to improve further in 2H. Management expects its gross margins to normalise at 35-36% in next 18-24 months, led by benefits of price hikes and CPCB-4 norms.

*CPCB-4 norms to drive pre-buying in 1HCY23: Management expects pre-buying demand in 4QFY23/1QFY24, prior to CPCB-4 implementation. This should result in market share gains for KKC due to its technology superiority vs local players and also provide access to other new markets in EU and US. While exact quantum of price hikes was not disclosed, management highlighted that it will be lower than 50% price hike seen in automotive industry post BS-6 norms implementation.

*Maintain BUY with revised TP of INR 1,500: We forecast revenue and PAT CAGR of 16% and 19% over FY22-25E, as we expect easing of supply chain constraints, market share gains post CPCB-4 norms and new product launches in export markets to drive profitability. We maintain BUY with revised TP of INR 1,500, as we roll forward by 6 months to Mar’24. Key Risk: Regulatory hurdles for diesel gensets.

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