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Witnessing a smoother transition to new norms

From our recent interaction with the management, Cummins India (KKC) appears to be well positioned to benefit from the change in emission norms for diesel gensets. The CPCB 4+ norms have been in effect since 1 st Jul’24. Contrary to expectations, demand has so far remained strong despite price hikes of 15-35% across nodes. This demand is being led by the refueling of channel inventory with CPCB 4+ gensets. KKC is striving to maintain high margins as experienced during the last few quarters through cost-rationalization measures and an improved product mix. The industrial segment is benefitting from the strong construction cycle, and the distribution segment is gaining from better market reach. Exports appear to have bottomed out and could witness improvement in the coming quarters. We thus maintain our positive stance on KKC and reiterate our BUY rating on the stock with an unchanged TP of INR4,300 (based on 45x P/E on two-year forward earnings).

Powergen segment’s portfolio well accepted in the market

Post-implementation of CPCB 4+ norms from 24th Jul’24, the overall genset market size has expanded 35-40%. The inventory filling exercise, coupled with normal demand across all segments, is leading to improved volumes even in a post-normal transition quarter. During FY24, the powergen segment’s demand gained from: 1) pre-buying benefits, 2) higher sales from the project business for the data center, 3) a higher share of nearly 25-30% of CPCB 4+ products, and 4) the lag effect of pricing increases. Going forward, the segment will be driven by strong demand and pricing gains in FY25. In the CPCB 4+ segment, the market will stabilize in the coming quarters, with only CPCB 4+ products being available on the market. Hence, if demand remains strong, the prices of CPCB 4+ products will continue to remain elevated. Demand for data centers is growing in high double digits, and KKC’s HHP portfolio is constantly benefiting from this demand. KKC remains a leader in the data center market as the reliability of gensets is being measured up to four decimal points and other local players are yet to catch up. Along with this, KKC also maintained its positive stance on demand sustainability. This was because the demand for gensets as a backup will continue to remain despite government efforts to ramp up power capacity and even with lower prices of batteries as an alternative source of power.

Distribution segment will continue growing rapidly

The distribution business is growing at a healthy pace over the past few years as the installed base is growing each year, coupled with higher utilization leading to improved demand for aftermarket solutions, which is a function of both time and usage of gensets. KKC is also benefiting from strong demand pull as well as its vast distribution network and increased penetration towards Tier 2 and Tier 3 cities. Along with this, the growth momentum of the distribution business will be supported by demand for spares and services of CPCB 4+ gensets which will be more expensive as compared to that of CPCB 2 gensets. KKC has already launched Ashwasan 4+ extended warranty for new gensets. We expect the distribution segment to report a 25% CAGR over FY24-27.

Industrial segment benefitting from growth across all sub-segments The demand in the industrial segment is fueled by growth visible in all key segments such as construction, railways, mining, marine, and defense. In the railways segment, the demand for Diesel Electric Tower Cars (DETCs) remains strong. However, demand for hotel load converters is yet to kick in for Cummins. The company is also witnessing strong demand from the defense segment. We expect the industrial segment to clock a 14% CAGR over FY24-27. Exports hit by weak demand and dumping from other countries The export markets had witnessed dumping from various countries, which led to price disruption. KKC is cautiously treading this market and is trying to position its products well in each market so as to capitalize as and when demand recovers. India is already ahead of other developed countries on emission norms, and hence, KKC will try to position CPCB 4+ products in the US and Europe. We expect an export revenue of INR17.4b/INR19.6b/INR22.1b for FY25/FY26/FY27.

Cost benefits playing out well

KKC continues to remain focused on localizing the costs and intends to take the indigenization level for CPCB 4+ to nearly 75-80%. KKC implemented material cost reduction initiatives in the last few years, and the benefits of these initiatives are now visible. With commodity prices under control, the company intends to either maintain or improve its margins from current levels.

Financial outlook

We retain our estimates and expect revenue/PAT CAGR of 18%/21% over FY24-27. We keep our margin estimates of 20.4%/20.5%/20.5% intact for FY25/FY26/FY27. Our estimates factor in a gross margin of 35.6% vs. 37.8% in 1QFY25, as we expect some parts of the benefit of low-cost RM inventory to wane with the increase in commodity prices of late, particularly copper and aluminum.

Valuation and view

The stock is currently trading at 42.2x/35.6x FY26/27E EPS. We maintain our TP of INR4,300 based on 45x P/E on two year forward earnings. Reiterate BUY.

Key risks and concerns

Key risks to our recommendation would come from lower-than-expected demand for key segments, higher commodity prices, increased competitive intensity, and a lower-than-expected recovery in exports.

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