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Profitability hit by higher RM costs

Cummins (KKC)’s 1QFY27 result was lower than our expectations due to margin weakness. Higher RM prices and delays in pass-through of price hikes impacted margins adversely. We expect the price hikes taken across ranges of powergen during the quarter to get reflected in coming quarters. Strong growth in revenue was led mainly by powergen, and that too particularly data center-led revenue, both from colocation-based DC as well as project-based revenue from hyperscalers. Momentum continues to remain strong from hyperscaler-led project revenue booking. Distribution and industrial business grew at a slower pace. We expect powergen segment to continue to benefit from strong demand from data centers and distribution segment to benefit from higher penetration and warranty renewal. We do expect industrial segment growth to get impacted by weakness in construction and compressors, while exports have already started reviving sequentially. We expect positive margin levers to come from

1) price hikes

2) higher distribution segment revenue

3) potential improvement in exports over the next two years. We revise our estimates to bake in 1QFY27 margin performance and slightly lower margins. We reiterate our BUY rating with a TP of INR6,500 (vs INR6,600 earlier) based on an average of 45x P/E and DCF on two-year forward estimates.

Beat on revenue, but miss on profitability due to margin contraction

KKC’s 1QFY27 revenue beat our estimates, whereas lower-than-expected margins led to a miss on profitability. Revenue increased 18% YoY to INR34.3b, 7% above our estimates. This was above the parent entity’s commentary on revenue from India, including JVs, increasing 6% YoY during the quarter. Domestic sales grew 22% YoY to INR28.5b (9% above our estimates), while export sales were flat YoY at INR5.2b (5% above our estimates). Gross margin stood at 33.5% vs. our estimate of 36.0%. Higher commodity prices due to ongoing geopolitical uncertainties led to a lower-than-expected EBITDA margin of 18.0% vs. our estimate of 21.3%. Absolute EBITDA remained broadly flat YoY at INR6.2b vs. our estimate of INR6.8b. Adj PAT declined 2% YoY to INR5.4b vs. our estimate of INR6.2b. The miss was mainly due to a dip in margins.

Powergen segment to benefit from price hikes and DC-led demand

Powergen revenue grew by 35% YoY for 1QFY27, driven by strong demand for the data center-led offerings. Revenue growth in the non-DC-led portfolio remained in single digits, and management indicated scope for further improvement in this segment. Demand is generated from manufacturing, commercial, residential, and data centers. Data centre formed 40% of total powergen revenue for 1QFY27 (vs. 23% in 1QFY26). The company has taken price increases across ranges and will keep evaluating commodity price increases, freight costs, and supply chain issues to evaluate further price hikes. Going forward, we expect the powergen segment to benefit from 1) price hikes taken so far across the ranges to pass on RM cost pressure and 2) strong demand from co-location DCs as well as hyperscalers. We tweak our powergen revenue estimates and expect revenue to clock a CAGR of 19% over FY26-29.

Valuation and outlook

We cut our FY27/FY28 estimates by 4%/1% to factor in 1Q performance and slightly lower margins. We thus expect KKC’s revenue/EBITDA/PAT to clock a CAGR of 18%/19%/20% over FY26-29. The stock is currently trading at 52.4x/42.2x/35.8x on FY27/FY28/FY29 EPS. We arrive at our revised TP of INR6,500 (vs. INR6,600), based on an average of 45x P/E and DCF two-year forward estimates. Reiterate BUY.

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