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Drivers in place for further re-rating

We interacted with the management of Cummins India Ltd (CIL), and the key takeaways are highlighted as below. Over the past 12 months CIL has outperformed S&P–BSE Cap Goods Index by ~28% on the back of overall cyclical recovery and uptick in margins. Going ahead, we make a case of PE expansion, given (1) structural changes in emission norms, (2) strong budget roadmap for infrastructure creation aligning with CIL product portfolio, (3) ahead-of-peers leadership in clean energy solutions, (4) recovery in end exports markets and, lastly, (5) probable long-term case for CIL-CTIL merger. We maintain BUY on CIL with a revised TP of Rs 1,068 (SOTP); upgrade P/E from 25x to 30x FY23E EPS (average 6.5yrs P/E post May-14, NDA Govt).

* Economic recovery faster than expected, government’s infra push positive: Economic rebound and emphasis on long-term infra creation by the government in the FY22 budget bodes well for the capital goods sector. Supply chain continues to be a concern, especially on the electronics and semiconductors side. However, CIL is able to manage this relatively better being part of a large global group, which helps it in sourcing competitively. Commodity costs have increased and are being monitored closely. CIL is now operating at ~100% of manned capacity.

* Growth guidance - targeting to outperform nominal GDP growth: CIL has not given any definitive growth guidance though FY22E revenue is pegged to be better than FY19. Over longer term, the intent is to beat nominal GDP growth in domestic and relevant exports markets. This pegs the growth number around 12-15% over medium to long to term.

* Margins under near term pressure, price action to aid recovery: given commodity price uptick, and return of expenses (employee expenses & discretionary spend) due to reversals of temporary measures related to COVID taken earlier, as business volumes pick up, margins might be under pressure over the next 2 quarters. Appropriate price actions may be taken, but there is usually a lag period of 2-4 quarters before this reflects in margins. CIL needs to get higher volume of business to maximise utilisation and sustain these higher EBIDTA margins (16.5-17%). Product readiness, courtesy group experience from other leading markets, puts the company in a strong position to derive better value than competition.

* CIL to drive alternate fuels technology, clarity awaited on CIL/CTIL merger: Hydrogen, fuel cells and alternate fuel electrification technology will be pushed through CIL in segments like Rail, Infra, Marine, etc. where CIL has a decent scale, and is bidding actively. Incubation of this new business will take some time, and it will be a medium-term driver, while contribution in the short term will be negligible. Government’s thrust on the same in the form of National Hydrogen Energy Mission is encouraging. Non CIL aligned business may continue to happen through CTIL. Any corporate action between CIL-CTIL will be driven by shareholders and parent CMI.

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