Cummins India Limited - Maintains profitability despite challenges - Antique

The Central Pollution Control Board recently notified new emission norms CPCB-II for diesel generator sets, which is equivalent to EU Stage IIIA norms. This is a positive development for Cummins India as it is the market leader in the Indian diesel power generation segment and stands to benefit due to its technological edge over its competitors. We expect sharp earnings recovery in FY15, post a dismal FY14. The stock trades at 16x FY15e earnings, which is at a significant discount to its historical valuations. It continues to generate RoE of over 25%, even in an adverse business environment, which is highly impressive. We maintain our Buy recommendation.

New emission norms big positive for Cummins India

The new emission norms, likely be implemented from April 1, 2014, will change the dynamics of the Indian genset industry. Typically, engines form 50-60% of gensets and compliance to new norms will increase diesel engine prices by 15-20%. We see Cummins India launching CPCB-II compliant engines at a lower cost per unit vs competition, which will help boost market share and margins over the next two-to-three years.

Long-term outlook remains strong

Power shortages in India will continue to drive gensets demand. Despite gensets largely used for standby applications, increased power availability has had a limited impact on demand, which is largely driven by growth in services, manufacturing - particularly small and medium enterprises, and real estate sectors. There is a huge unmet demand potential for diesel engines from infrastructure equipment space, particularly construction and mining equipment sectors. Cummins India is a key partner in Cummins Inc's global footprint. Outsourcing by parent will remain a key long-term growth driver for the Indian entity.

Earnings to recover 23% in FY15; Expect margin improvement

Cummins India's EBITDA margins are in the 17-19% range during FY10-FY14 from 12-14% between FY02 and FY06. The company has shown tremendous capability in value engineering by reducing material and other overhead costs almost every year over the past 10 years. With the new emission norms, there is scope for further improvement in margins going forward.

Valuations

The stock is expected to command premium valuations due to its strong historical record of consistent earnings growth and an attractive return ratio of 25-28% from an unleveraged balance sheet. Historically, the company has traded in the P/E range of 15-25x one-year forward earnings. We value the company at 20x FY15e earnings, implying a target price of INR570 per share.

Source : Equity Bulls

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