We held meetings for investors with Cummins management including President of Engine Business Rich Freeland and Vice President of Investor Relations Mark Smith. Mr. Freeland oversees development, manufacturing, marketing, and sales for the company’s largest business unit. Following the meetings, our positive thesis remains unchanged. The outlook for the year is still supported, based on the order book and improving indicators such as parts utilization and commercial vehicle trends, especially in North America.
The variability could come from power generation which is still recovering from a low base and faces a challenging environment, though we believe there should still be sequential improvements. There is still risk in this business, but it is early in the year. Emerging markets are still mixed, though the company does not factor in much growth from this category into its outlook. This year will be driven mostly by North America, and we are hopeful that emerging markets such as India improve over time.
The downside scenario appears to be well provisioned for, and thus we are confident on the overall outlook for the year and anticipate upside optionality over time at this point. The distribution consolidation strategy is on track to deliver $400 million in incremental revenue this year and $1.0 billion by next year. This could be further benefited by increases in parts sales and other favorable trends in North America.
We believe Cummins can deliver the high end of its engines and components growth forecasts, while power generation sales have a greater hurdle to jump over. From a margin perspective, engines and components segments have upside, in our opinion, while power generation’s slow start creates high sequential threshold rates. North America is more than 50% of consolidated sales and hits all segments. We continue to view Cummins as an attractive stock and growth story, based on the following attractive attributes: emissions-related secular growth theme, the company’s high market share, especially in North America, leading technology and new product introductions that have a better cost basis, developed market cyclical upside, strong balance sheet, shareholder friendly capital allocation, distribution acquisition accretion, solid management team, high returns-on-invested capital, and optionality on the power generation business.
The company has done a solid job of delivering healthy EPS figures despite turbulent end-market demand across its product line, but North America (~50% of sales) has inflected positively. In fact, most of the company’s end-markets are well off of prior peak levels and so there is optionality on a turn. So far this year Cummins stock is up 11%, versus the group average increase of 4%, and the S&P 500 return of 5%.
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