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Beat on earnings aided by higher other income

Slower pace of recovery; cost measures likely to continue

* Cummins India (KKC)’s 4QFY21 revenue growth was weak, in line with expectations. It increased 18% YoY on a weak base (4QFY20: -22%). Domestic revenue was up ~26% YoY, while exports remained sluggish (flat YoY). However, persistent cost-cutting measures (employee cost down 5% YoY and other expenses down 30% YoY) resulted in EBITDA margins of 13.4%. Adj. PAT stood 53% higher YoY and was 19% above our estimate, led by higher-than-estimated other income.

* Revenue normalization is taking longer than expected (in line with our bearish thesis), especially as exports have also failed to cheer. While commodity costs have risen significantly, the management is trying to mitigate the same via price increases – some of the increases are seen with a certain lag. Notably, the EBITDA margin surprise was attributable to employee cost cuts and sharp decline in other expenses – this is not sustainable beyond the next couple of quarters, in our view.

* (a) Management commentary/indications on likely future opportunities in hydrogen fuel cell technologies for the listed entity and (b) no decline or affirmation toward corporate development involving a listed and unlisted entity merger may keep investors guessing on the optionality. While we maintain our long-term thesis on structural issues in the current business, valuations could remain buoyant in the medium term on account of option value. The recent disruption caused by the second COVID wave could potentially delay recovery across the key end markets. We largely maintain our FY22/FY23E estimates and maintain our Sell rating, with TP of INR535 (20x FY23 EPS)

Weak revenue growth (in-line), lower other expenses lead to surprise

* 4QFY21 snapshot: Revenue was up 18% YoY to INR12.5b, in line with our estimate. The domestic revenue split was as follows: Power Generation – INR3.6b (+34% YoY), Industrial – INR2.7b, and Distribution – INR3.4b (+33% YoY). The exports revenue split was as follows: HHP – INR1.4b (-8% YoY) and LHP – INR1b (+4% YoY). Employee costs fell 5% YoY, and other expenses came in 30% lower. EBITDA was in-line at INR1.7b (+151% YoY on a low base). The EBITDA margin stood at 13.4%. Other income came in at INR1.1b (up 24% YoY and higher than our estimate of INR697m). PBT stood at INR2.5b (23% above our estimate). Adjusted PAT stood at INR1.9b, up 53% YoY (19% above our estimate).

* FY21 snapshot: Revenue fell 16% YoY to INR43.3b. Domestic/Export revenue fell 18%/11% YoY to INR31b/INR11.5b. Employee costs came in 12% lower, and other expenses fell ~22% YoY. EBITDA stood at INR5.8b (flat YoY). The EBITDA margin rose 200bp YoY to 13.4%. Adjusted PAT was down 14% YoY to INR5.6b, weighed by a higher tax rate. Focus on the working capital cycle led to CFO of INR7.9b (v/s INR6b in FY20). The net cash position improved to INR12.8b (v/s INR7.5b in FY20).

Key management call highlights

* KKC is operating at 50% manpower and efficiency over Apr–May’21 due to the COVID-led disruption. The company was running at ~70% efficiency up to Mar’21 and had expected to further ramp up operations over Apr–May’21.

* KKC is mitigating the surge in commodity prices through material cost optimization and by passing on the cost to clients whose contracts have escalations built in. For other contracts, price increases are taken via negotiations, which have a lag effect. KKC is not seeing any adverse impact on demand due to commodity price inflation. Furthermore, another round of price increase would be needed to mitigate the entire impact of the rising costs.

* Other expenses, down 30% YoY and at just 9% of sales in 4QFY21 (down ~23% YoY and ~12% of sales in FY21), fueled the surprise on the EBITDA margin. This was attributable to strong cost-cutting measures. While many components in which cost cuts were implemented would return, the exact timing and extent of the normalization remain uncertain amid the COVID-led disruption. In our view, as the business is slower to recover vis-à-vis other sectors, KKC’s cost-cutting measures may be implemented for longer. Also, cost items such as royalties, warranty provisions, etc., may continue to be lower in the current year, but this may not be sustainable over the longer term.

* Currently, there are no defined timelines for when the hydrogen fuel cell technology would be commercialized. Cummins India continues to work on these technologies via its partner companies. As things stand today, the management expects these opportunities in the listed entity, along with investments.

Valuation and view

While we maintain our long-term thesis on structural issues in the current business, valuations could remain buoyant in the medium term on account of option value (future technologies such as hydrogen fuel cell related opportunities and any corporate development between the listed and unlisted entities). The recent disruption caused by the second COVID wave could possibly delay recovery across the key end markets. We largely maintain our FY22/FY23E estimates and maintain our Sell rating, with TP of INR535 (20x FY23 EPS).

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