Cummins Inc: An Intriguing Opportunity for High Dividend Growth

Introduction

Cummins Inc (CMI) is a leading designer, distributor and manufacturer of diesel and natural gas engines.  As I will illustrate in the analyze- out-loud video associated with this article, a recent drop in the company stock price has created a significant long-term opportunity for the dividend growth investor.  Attractive valuation and the company’s commitment to shareholder value through generous dividend payments and share buybacks are two primary factors that attracted me to this high-quality dividend growth opportunity.  The company’s recent 25% increase in its dividend validates my position and thesis.

Short Business Description Courtesy S&P Capital IQ

For those not entirely familiar with the company, the following short business description summarizes the company’s businesses:

“Cummins Inc. designs, manufactures, distributes, and services diesel and natural gas engines, and engine-related component products. It operates in four segments: Engine, Distribution, Components, and Power Generation.

The Engine segment offers various diesel and natural gas powered engines under the Cummins and other customer brands for the heavy-and medium-duty truck, bus, recreational vehicle, light-duty automotive, agricultural, construction, mining, marine, oil and gas, rail, and governmental equipment markets. This segment also provides new parts and services, as well as remanufactured parts and engines.

The Distribution segment distributes and services parts and filtration products, power generation products, and engines, as well as offers service solutions, including maintenance contracts, engineering services, and integrated products.

The Components segment offers emission solutions, including custom engineering systems and integrated controls, oxidation catalysts, particulate filters, oxides of nitrogen reduction systems, and engineered components; turbochargers for light-duty, mid-range, heavy-duty, and high-horsepower diesel markets; air and fuel filters, fuel water separators, lube and hydraulic filters, coolants, diesel exhaust fluids, fuel additives, and other filtration systems; and fuel systems for heavy-duty on-highway diesel engine applications, as well as remanufactures fuel systems.

The Power Generation segment designs and manufactures components that make up power generation systems, including controls, alternators, transfer switches, and switchgears, as well as provides power generation systems, components, and services.

The company sells its products to original equipment manufacturers, distributors, and other customers. As of July 28, 2015, it operated through approximately 600 company-owned and independent distributor locations, and 7,200 dealer locations worldwide. The company was founded in 1919 and is headquartered in Columbus, Indiana.”

Additionally, the following breakdown of segment sales courtesy of Zacks provides additional insights into the makeup of their various business segments and the contribution of each to sales and profits:

“The Engine segment (55.5% of net sales in the first half of 2015) produces engines and parts for sale to customers in on-highway and industrial markets. The engines are used in trucks, buses, recreational vehicles and various industrial applications such as construction, mining, agriculture, marine, oil and gas, rail and military.

The Power Generation segment (14.7%) sells engines, generator sets and alternators, and rents power equipment for both standby and prime power uses. The power generation products are organized around the Power products, Power systems, Alternators and Power Solutions businesses.

The Components segment (27.7%) has four businesses: Cummins Filtration, Cummins Turbo Technologies, Cummins Fuel Systems and Cummins Emission Solutions. Under the filtration business, the company supplies filtration, exhaust, coolant and chemical products. Turbo technologies design, manufacture and market turbochargers for commercial and light-duty diesel applications.

The Distribution segment (30.6%) includes wholly– and partially–owned distributorships engaged in wholesaling engines, generator sets and service parts, along with servicing and repairing the company’s products and maintaining relationships with original equipment manufacturers (OEMs) globally. The company’s distributors serve a diverse customer base with 43% of revenues coming from the wholesaling of new power equipment and the remaining coming from parts and filtration, and service repairs.”

Of these 4 segments, the engine segment produces the majority of Cummins’ earnings, followed by the component segment, the distribution segment, and last, the power generation segment.  Approximately half of their profits and more than half of their sales are derived from the engine segment.  In January 2015, the company announced its commitment to meeting the European Union (EU) and U.S.  Environmental Protection Agency low emission regulations.  I believe this represents a solid growth opportunity as the company is committed to meeting both fuel efficiency and emissions standards.  They’ve already announced and showcased several new innovative engines in their lineup.

Additionally, the company’s distribution segment has been actively acquiring North American distributors.  The company has made 10 acquisitions over the past 2 years which they forecast will generate incremental revenues of approximately $600 million in 2015.  Management forecasts the synergies generated from these acquisitions will increase earnings per share by $.20 in 2015.

I believe that much of the recent price weakness has been a result of exaggerated fears caused by recent poor performance in China and Brazil.  However, it’s important to note that China, Latin America and Mexico combined only comprise about 15% of their revenues.  Consequently, although China and Brazil are experiencing short-term stress, I believe the long-term opportunity with both areas is quite large.  I will go in more detail of why I like Cummins in the analyze- out-loud video.

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