Buy Cummins India - A bright spot in the power sector mess - IIFL

As a market leading diesel engine supplier, Cummins India (KKC) is relatively immune to the Indian capex cycle. Outlook for gensets delivering prime power improves with diminishing power capex and need for back-up power boosts demand in an upcycle. KKC's brand franchise is difficult to replicate in an industry requiring high after-sales customer engagement. Its leadership position would sustain superior margins and returns. Valuations at 16x FY15ii discount near-term earnings but do not reflect KKC's unique position among cap-goods vendors wherein price is not the main basis of competition. We initiate with a BUY.

Structural growth story relatively immune to cycles: KKC benefitsfrom the continued, severe power deficit in India. With multiple issues plaguing the power sector, grid power will continue to be unreliable. This engenders robust demand for diesel generators. KKC with industryleading product offerings and strong distribution network, is well placed to ride the robust demand. Pickup in industrial-capex-led demand will further boost revenue growth for the company.

Strong brand to aid margin improvement: KKC derives strength from the technological leadership of its parent, which enables it to offer a range of superior products. With emission norms becoming stricter, this technological superiority is especially useful. Operating leverage driven by robust demand environment, focus on cost efficiencies, ability to indigenise rapidly and stable royalty payment to parent would help improve margins. Prospects of increased competition in the high margin segments are dim.

Robust fundamentals justify premium valuations: We expect KKC to register 16.5% net profit Cagr over FY12-15 driven by 13.6% revenue Cagr and 100bps Ebitda margin expansion. ROE should improve to 32-33% in FY14-15 despite high capex. This contrasts with other capital goods vendors such as Siemens, ABB, and Thermax that have little visibility of an improvement. Key risks include: (1) Cummins Inc choosing vehicles other than KKC for launching new products; and (2) investments strategically important to the group but earning sub-par returns for KKC.

Source : Equity Bulls

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