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Good quarter; future growth remains key

Cummins India (CIL) has reported a good set of numbers with its highest-ever sales in Q2FY23. Revenue /EBITDA/PAT grew 13%/12%/15% YoY to Rs16.8b/Rs2.9/Rs2.5bn, respectively. This was led by both volume growth and inflation led price hikes. Exports and domestic segments grew 21% and 11% YoY. Higher inventory lead time and supply-chain issues limited revenue growth while demand remained high across industries. EBITDA margin was stable at ~15% (improved 220bps QoQ) despite 120bps drop in gross margin at 31.8%. We expect gross margin to see an uptick on improving supply chain and further price hikes. The increasing availability of electronic and other components would also result in higher utilisation from 70-80% currently. Strong growth is likely to sustain in data centre, commercial realty, pharma, bio-tech and manufacturing sectors which may drive growth in powergen segment. Implementation of CPCB IV+ from Jul’23 could result in pre-buying during H1CY23. Due to recent run up in stock, we maintain our HOLD rating on the stock. We roll forward our valuation estimate to FY25E and arrive at a revised target price of Rs1,393 (earlier: Rs1,181).

* Healthy growth in all domestic segments: During the quarter, domestic sales grew 11% YoY led by powergen (up 6%), distribution (up 22%) and industrial segment (up 10%). As per the management, mining, marine and defence have performed better than expectations. Railways is likely to bounce back led by new products launched recently. Construction segment, which has been slow in recovery, is likely to see improvement.

* Export outperformance continues: Exports grew 21% YoY to Rs5.3bn (highest ever) backed by strengthening of the export-focused LHP (grew +49% YoY during Q2FY23) products. Demand from key geographies like APAC, Lat-Am and the Middle East remained robust. Management expects exports to see further boost post implementation of CPCB IV+ norms as the products will adhere to high global emission standards.

* Prior price hikes and higher operating leverage helped sustain EBITDA margin: With supply-chain constraints and price lag effect, gross margin was impacted by 120bps YoY. However, higher operating leverage enabled EBITDA margin to remain stable YoY at 15%. We expect margin to improve gradually with further price hikes and improving supply of key electronics components and spare parts.

* Maintain HOLD: We expect near-term growth from i) industrial segment, as railway order intake picks up on the back of electrification and Vande Bharat trains; and ii) exports led by market-specific LHP products launched in FY22. Additionally, with the recent correction in commodity prices and ability of the company to take price hikes even in a highly competitive scenario, we expect margins to expand gradually in coming quarters

Valuation and outlook

We expect the current growth trend to continue on the back of industrial capex revival and CPCB IV+ norms-led pre-buying. Additionally, due to near-term margin expansion triggers, led by pricing action and reduction in commodity prices, we raise our earnings estimate for FY23E and FY24E by 1% and 3.6%, respectively. However, due to recent run up in stock (34% in 6 months) we maintain our HOLD rating.

We have introduced our FY25E earnings and accordingly roll forward our valuation. We assign a core earnings valuation multiple of 28x FY25E and add back the cash and discount the lease rentals @6% for 10 years. This leads to a target price of Rs1,393 (previously: Rs1,181).

Key risks: i) Delay in passing on of input costs might impact margins, ii) further disruption in supply chain.

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