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Add Cummins India Ltd For Target Rs.720

Improving earnings visibility; Upgrade to ‘ADD’

Cummins India (KKC) reported healthy Q3FY21 performance (26% qoq EBITDA growth) led by demand recovery in power generation (PG) business & strong margins due to favorable sales mix, cost control initiatives & lower employee cost. We believe, Government’s thrust on the Road, Rail and Metro projects (National Infra pipeline of ~Rs100trn+) along with new investments into data centre and 5G telecom network will aid in faster demand revival for KKC’s products. In addition, mgmt. expects healthy pre‐ buy demand before implementation of new emission norms. Though KKC reported 16.7% adjusted EBITDAM over Q2‐Q3FY21, we expect it to normalize at ~15% owing to likely tilt in sales mix in favor of PG, rollback of few costs & commodity price headwinds. We raise FY22 earnings estimates by 30% to factor in better than expected recovery in earlier estimated sales & margins. Hence, we upgrade KKC to ‘ADD’ rating with revised TP of Rs720 based on SOTP methodology.

Faster sales recovery led by multiple tailwinds

Domestic demand traction has improved significantly for KKC especially from sectors like Data Center, infra, mining, construction etc., while hospitality, retail, and commercial segments are recovering relatively at slower pace. Export markets like South Asia, MENA & LATAM are also showing good signs of demand recovery while Europe & USA remained weak due to 2nd wave of COVID. KKC is eying for market share gain through customized offerings, & by increasing power density & fuel economy of products. CPCB IV norms implementation can lead to further market share gains. KKC is looking at ideas for the long term, such as merging Cummins Technology India Limited (CTIL unlisted group entity) with itself, but nothing is planned as of now. Mgmt. indicated that hydrogen technologies for rail & construction (where KKC is already present) will remain with the company, which offers high growth potential.

Industrial sales are directly dependent on infra awarding activities, hence pick up in NHAI ordering, roads, rail & metro projects lead to strong sales volumes. Under the National infrastructure pipeline Government has laid out aggressive investment plan of Rs100trn+. Hence, we expect strong growth prospects for KKC’s industrial business. Given the large distribution network & large installed base of machines (0.6mn+), demand for spares is expected to remain robust.  

Sustainable cost reduction initiatives   

Cost optimization measures & VRS scheme coupled with favorable sales mix in terms of higher distribution & exports sales has resulted in adjusted EBITDA margins of 16.7% (excl. impairment of Rs230mn in Q2) during Q2‐Q3FY21. KKC provided customized value‐added products for data center, which helped in better price realization. We assume 15% EBITDAM in Q4FY21 to factor in rise in raw material prices & roll back of few expenses as guided by management. The Company is planning to take price hike in Q1FY22 to mitigate the impact of adverse commodity prices.

Valuation re‐rating on the cards  

KKC is at an advantage versus other domestic peers and is ahead with regards to its preparedness, on the back of a global portfolio which is already compliant with the new norms and will need certain modifications to adapt to local conditions. Strong FCF and dividend pay‐out caps downside risks for KKC, while pickup in demand can aid earning upsides through operating leverage. The stock is currently trading at 24x/21x FY22/FY23 earnings which is in line with its 15‐year avg. 1‐yr fwd P/E multiple of 22x. We expect valuation re‐rating of the stock with EBITDA CAGR of 17% over FY21‐ FY23E, improvement in return ratios & better earnings quality (Non‐core income 29% of FY23E PBT vs 37% in FY20). Hence, we upgrade KKC to ‘ADD’ with TP of Rs720.

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