Cummins India. Strengthening the franchisee! Source: Company Data; PL Research

Transcription

1 Strengthening the franchisee! July 15, 2016 Kunal Sheth Samir Bendre Rating Accumulate Price Rs820 Target Price Rs881 Implied Upside 7.4% Sensex 27,942 Nifty 8,565 (Prices as on July 14, 2016) Trading data Market Cap. (Rs bn) Shares o/s (m) M Avg. Daily value Major shareholders Promoters 51.00% Foreign 17.10% Domestic Inst % Public & Other 13.82% Stock Performance (%) 1M 6M 12M Absolute 2.2 (17.1) (14.5) Relative (3.6) (29.9) (14.5) How we differ from Consensus EPS (Rs) PL Cons. % Diff Price Performance (RIC: CUMM.BO, BB: KKC IN) (Rs) 1,400 1,200 1, Jul15 Sep15 Source: Bloomberg Nov15 Jan16 Mar16 May16 Jul16 Cummins India (CIL) continues to undertake various measures to increase its competitive advantage by investing in capacities, technology and customer satisfaction and ensure the franchisee emerges stronger in the upcycle. In the long term, with greater focus on more stringent environmental norms, the company believes it is positioned favourably as pioneer in producing engines with higher fuelefficiency and cleaner technology. CIL believes it is positioned strongly in all its export markets and substantial business development initiatives to diversify into new territories with new and existing products being undertaken to secure long term growth potential. We remain positive on CIL s medium/longterm potential in the domestic market, driven by structural factors like revival in Infrastructure/Industrial demand, unreliable quality of power in India, lack of creditable options for power backup and strong export potential. While CIL is working in the right direction to further strengthen the franchisee and benefit from the upturn, however, recent instance of shift of K19 engine from Seymour facility to Phaltan, closing of Phaltan Mid Range Upfit Centre (PMUC) and proposed shifting of certain activities to other existing factories of the Cummins Group will lead to uncertainty in the minds of investors. Contd...2 Key financials (Y/e March) E 2018E Revenues 44,058 47,243 49,910 55,787 Growth (%) EBITDA 7,318 7,604 8,435 9,763 PAT 7,859 7,519 7,848 9,296 EPS (Rs) Growth (%) 38.5 (4.3) Net DPS (Rs) Profitability & Valuation E 2018E EBITDA margin (%) RoE (%) RoCE (%) EV / sales (x) EV / EBITDA (x) PE (x) P / BV (x) Net dividend yield (%) Source: Company Data; PL Research Annual Report Analysis Prabhudas Lilladher Pvt. Ltd. and/or its associates (the 'Firm') does and/or seeks to do business with companies covered in its research reports. As a result investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of the report. Investors should consider this report as only a single factor in making their investment decision. Please refer to important disclosures and disclaimers at the end of the report

2 Key highlights from the FY16 Annual Report of CIL: 1) CIL has invested in a disciplined manner over the years in increasing high quality manufacturing capacities to ensure CIL can respond quickly to the first signs of economic recovery, domestically as well as globally. 2) Domestic power Genset business is likely to see volume increase in the coming year on account of gaining market share across segments. 3) With greater focus on stringent environmental norms in the future, CIL believes it is positioned favourably as pioneer in producing engines with higher fuelefficiency and cleaner technology. 4) CIL is positioned strategically across all its export markets and substantial business development initiatives have been done to diversify into new territories with new as well as existing products. 5) Positive outlook for most end markets like Construction, Railways, Coal Mining, Marine etc. 6) CIL continues to focus on improving customer support & engagement through the formation of key account management structure and prioritizing critical customer segments. Introduction of the CRM system called Cummins Dealer Operating System (CDOS) was completed in all dealerships across India last year. CIL is focussed on employing data analytics and business intelligence on the generated data for enhancing customer s experience and delight. 7) Various costcutting initiatives like (ACE, TRIMS etc.) continue to yield significant results in the face of increased competitive landscape 8) FCF increased by 26% to Rs2bn. Policy uncertainty/need more clarification: After the shifting of the K19 engine from Seymour facility to Phaltan, the recent Annual report highlighted that the company is closing down the operation at the PMUC factory and looking at shifting certain activities, resources and operations of existing PMUC factory to other existing factories of the Cummins Group companies operating at Phaltan. We believe more clarity on parent s strategy for CIL would help investors access longterm potential of CIL. Extract from recent Q4FY16 con call transcript, comments of Mr Anant J. Talaulicar Chairman & Managing Director CIL Whatever today CIL has in its portfolio for domestic market will continue. We will add new platforms from a manufacturing perspective in the 100% Cumminsowned entity and the company will continue to market it for the domestic economy. Any new platforms, new technologies that are not in CIL s scope will fall in the 100% entity for exports. So again, domestic is all CIL, from a market perspective and domestic manufacturing is all CIL in terms of the portfolio that it already has and the capacities that it already has. This kind of a strategy essentially makes sure that CIL continues to be a profitably growing entity for good. And then of course, things that are outside its scope are brought in through with CTIL Cummins entity for best cost from Cummins Inc.(CMI) perspective. July 15,

3 Extract from Annual report 2016: Due to the economic slowdown, global demand for B, C, L series engines and gas engines has reduced drastically requiring the existing PMUC factory to operate below 40% utilization. In order to optimize costs and better utilization of the existing resources, it is proposed to outsource manufacturing of C series engines and gas engines by way of contract manufacturing and shift certain activities, resources and operations to other existing factories of Cummins Group companies operating at Phaltan which results into closure of PMUC operations by December After closure, the empty plant will be made available for Cummins Technologies India on rental basis at arm s length basis. Power segment looking at market share gains: Sales for Powergen segment was up 19% YoY. Post CPCBII implementation, which led to a challenging FY15 for the domestic business, CIL has been focussing on sales initiatives, cost reduction projects and quality improvements which has resulted in growing market share & revenue. While the domestic market sentiments remained stagnant last year, the domestic power generation business is likely to see volume increase in the coming financial year on account of gaining market share across segments. With the renewed push on infrastructure & industry development, CIL is optimistic about the future of the power generation business. In the long term, with greater focus on more stringent environmental norms in the future, CIL believes it is positioned favourably as a pioneer in producing engines with higher fuelefficiency and cleaner technology. Exhibit 1: Power segment Sales trend Power YoY gr. (RHS) 18,000 16,000 14,000 12,000 10,000 8,000 6,000 4,000 2, % 50.0% 40.0% 30.0% 20.0% 10.0% 0.0% 10.0% 20.0% 30.0% 40.0% Exports Focus on expanding reach: Exports for the year were down 3% YoY. In an initiative to leverage the available capacities, CIL has started exporting machined components to various engine manufacturing facilities with increased focus to become the preferred supplier of components. Further, as part of the initiative to add new geographies, CIL has supplied 14 litre engines to Canada and has also developed 14 Litres engine for the Marine application which is expected to bring volumes from North American region. The new product has also brought demand from the European region. The company is focused on July 15,

4 increasing the exports of its products. CIL started exporting six cylinder engines to Russia and China for excavator applications in the construction segment. The company has identified profitable opportunities to supply parts to various Cummins engine plants. New global products have resulted in additional export opportunities for diesel and gas business. With products from India gaining confidence in global markets, the company is receiving repeat orders from its global customers. CIL is positioned strongly in all its export markets and substantial business development initiatives to diversify into new territories with new and existing products being undertaken. Exhibit 2: Export sales trend Exports YoY gr. (RHS) 20,000 15,000 10,000 5, % 100.0% 50.0% 0.0% 50.0% 100.0% Exhibit 3: FY16 Exports Breakup Heavy Duty 7% Spares 3% LHP 25% HHP 36% MHP 29% Industrial positive trends across end markets: Revenue in the Industrial Engine Business were up 10% YoY in FY16 mainly due to the increased sales in segments such as Construction, Compressor and Rail. Increase in government expenditure on Infrastructure, Road Building and Smart cities in the coming year is likely to help in the overall infrastructure development in the medium term. July 15,

5 Government s push for affordable housing, sanitation, urban and rural development will have positive implications for the construction market. Higher railway budget, coupled with greater focus of gauge conversion, is expected to boost the demand for track maintenance machines. Additionally, the focus on increasing last mile connectivity will provide growth in the Diesel Electric Multiple Unit (DEMU) segment; CIL built and shipped the first ever 50 litre electronic engine for DEMU manufactured by the Integral Coach Factory in Chennai. Increased privatization in coal mining and impetus towards higher production of coal by government would result in movement towards higher tonnage dump trucks. Fleet expansion and modernization by the Indian Navy and Coast Guard is leading to increased demand in the marine segment in FY17. With Government s focus on Oil & Gas by providing clarity in gas pricing, the market will see an upsurge in demand in gas compression market. Exhibit 4: Industrial sales trend IBU YoY gr. (RHS) 6,000 5,000 4,000 3,000 2,000 1, % 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% 5.0% 10.0% Automotive: The M&HCV market production (Medium and Heavy Commercial Vehicles GVW >7.5 Ton) grew by 27% YoY in FY16 after two years of sharp decline. Increase was driven by GDP growth, higher replacement demands, positive market sentiments and lower interest rates. BS IV emission norms implementation has begun in a phased manner across India from October 2015 onwards and is expected to be completed by April CIL is ready with a range of BS IV products to cater to all the needs of current segments. There is focus on developing fitformarket solutions to meet upcoming emission regulations and market needs. CIL is developing an EGR (Exhaust Gas Recirculation) solution to provide a simple yet lower cost solution. July 15,

6 Exhibit 5: Auto sales trend Auto YoY gr. (RHS) 3,000 2,500 2,000 1,500 1, % 150% 100% 50% 0% 50% Distribution Mining/Railways/Construction to drive growth: Distribution Business grew by around 10% in the last financial year. Maintaining consistent focus on growth segments of Mining, Railways and Construction helped spare parts business grow despite lower diesel generator utilization for power generation applications. The Service Solutions Business grew by doubledigits on account of longterm Mining and Railway AMC contracts. Cyclical demand from Railway, Mining and DBU managed OEMs helped bolsters engine sales. Growth in Rebuild engines and Batteries was impacted due to muted sales from the power generation segment. CIL continues to focus on improving customer support & engagement through the formation of key account management structure and prioritizing critical customer segments. Introduction of the CRM system called CDO) was completed in all dealerships across India last year and underwent a technical upgrade this year to open user interface, which enables the company to work towards improving customer support through mobile devices. This year, CIL is also focusing on employing data analytics and business intelligence on the generated data for enhancing customer s experience and delight. Power deficit in India has been hovering around 12% levels during Reduced power deficit levels leading to increased standby use of diesel gensets could impact demand for aftermarket products & services in genset applications. Outlook for FY17 is positive and CIL is expecting to carry on this positive growth trajectory on account of a healthy order board for spare parts, continued demand for replacement engines from key accounts and improving penetration in solutions contracts. One of the key initiatives of the DBU is to improve panindia customer reach through its dealerships for the PowerGen segment. CIL bolstered its presence in Distribution by fully acquiring a joint venture dealership within its DBU portfolio in order to get direct customer access and also to improve our understanding of last mile operations. July 15,

7 Exhibit 6: Distribution sales trend DBU YoY gr. (RHS) 12,000 10,000 8,000 6,000 4,000 2, % 15.0% 10.0% 5.0% 0.0% 5.0% 10.0% 15.0% 20.0% Costsaving initiatives: CIL continues to focus on reducing Total Cost of ownership of direct materials using established "Accelerated Cost Efficiency program which originally kicked off in 2005 and is now in the fourth phase, as ACE IV, generating savings of ~Rs2.3bn for the company (ACE III generated saving of Rs13bn since 2005). Other costreduction programs like TRIMS, which was launched in 2010 to reduce the Total Cost of Ownership in indirect materials and services by 10% every year, together with the purchasing projects in the indirect spend space, generated significant saving of Rs180m. The program continues to help CIL to consolidate indirect materials and services supply base, while leveraging expenditure better. A new initiative named AMaZe (Accelerated Move is towards Zerodefects) was launched across CIL this year to focus more heavily on improving quality. Exhibit 7: Savings trend Total Savings ACE Six Sigma TRIMS Technical centre: In order to sustain our technology leadership in India and across the globe, CIL is expanding its technological capabilities with the establishment of the Cummins Technical Centre India (CTCI), the largest research and development centre worldwide. CTCI is expected to become operational by end of CTCI will generate leading edge product and technology development as well as business specific product development capabilities and global product solutions to all of CIL s businesses worldwide, while leveraging the large talent pool of engineers in India. As emission norms in India become ever more stringent, CTCI will play a significant role in bringing advanced emission technologies at an affordable price to the Indian consumer. Total investment of Rs10bn is being shared approximately equally by CIL and Cummins Technologies India. July 15,

8 Other Update: Working capital days for CIL reduced by ~13 days to 111 days in FY16. Debtor days reduced by 5 days to 73 days. CIL s cash from operations was up by 45% YoY to Rs6.5bn in FY16 led by improved working capital. Free cash flow stood at Rs2bn. Royalty cost stood at 1% sales in FY16 (1.4% in FY15). Exhibit 8: Cash Flow Exhibit 9: Payout Ratio 8,000 Cash from operation FCF 70% 60% 6,000 50% 4,000 2,000 (2,000) 40% 30% 20% 10% 0% Exhibit 10: Royalty Royalty % sales (RHS) July 15,

9 Outlook and Valuation: The stock is trading at 29x FY17E earnings. We remain positive on CIL s medium/longterm potential in the domestic market, driven by structural factors like revival in Infrastructure/Industrial demand, unreliable quality of power in India and lack of creditable options for power backup and exports, given the strong demand for LHP machines in both, Asia and Africa. Low capitalization utilization of 65% also leaves upside surprise on margins once volumes improve. Maintain Accumulate. Exhibit 11: Oneyear forward PE Band P/E (x) Peak(x) Avg(x) Median(x) Min(x) Mar05 Oct05 Apr06 Nov06 May07 Dec07 Jun08 Dec08 Jul09 Jan10 Aug10 Feb11 Aug11 Mar12 Sep12 Apr13 Oct13 Apr14 Nov14 May15 Dec15 Jun16 Source: Company Data, Bloomberg, PL Research July 15,

10 Income Statement Y/e March E 2018E Net Revenue 44,058 47,243 49,910 55,787 Raw Material Expenses 27,066 29,593 30,894 34,532 Gross Profit 16,992 17,650 19,016 21,255 Employee Cost 3,913 4,210 4,242 4,742 Other Expenses 5,761 5,836 6,339 6,750 EBITDA 7,318 7,604 8,435 9,763 Depr. & Amortization ,080 Net Interest 13 9 Other Income 2,866 2,279 2,327 2,654 Profit before Tax 9,374 9,064 9,809 11,337 Total Tax 1,515 1,546 1,962 2,041 Profit after Tax 7,859 7,519 7,848 9,296 ExOd items / Min. Int. Adj. PAT 7,859 7,519 7,848 9,296 Avg. Shares O/S (m) EPS (Rs.) Cash Flow Abstract Y/e March E 2018E C/F from Operations 4,979 6,556 7,817 8,569 C/F from Investing (815) (1,720) (3,000) (4,000) C/F from Financing (4,229) (4,679) (4,330) (4,330) Inc. / Dec. in Cash (64) Opening Cash ,339 Closing Cash ,339 1,578 FCFF 3,803 3,594 3,817 4,569 FCFE 3,803 3,594 3,817 4,569 Key Financial Metrics Y/e March E 2018E Growth Revenue (%) EBITDA (%) PAT (%) 38.5 (4.3) EPS (%) 38.5 (4.3) Profitability EBITDA Margin (%) PAT Margin (%) RoCE (%) RoE (%) Balance Sheet Net Debt : Equity Net Wrkng Cap. (days) Valuation PER (x) P / B (x) EV / EBITDA (x) EV / Sales (x) Earnings Quality Eff. Tax Rate Other Inc / PBT Eff. Depr. Rate (%) FCFE / PAT Balance Sheet Abstract Y/e March E 2018E Shareholder's Funds 29,172 31,713 35,186 39,152 Total Debt Other Liabilities Total Liabilities 29,172 31,713 35,186 39,152 Net Fixed Assets 14,352 18,086 21,134 24,054 Goodwill Investments 4,650 3,354 2,354 1,354 Net Current Assets 10,800 11,090 12,514 14,560 Cash & Equivalents ,339 1,578 Other Current Assets 23,723 23,430 23,418 26,596 Current Liabilities 13,721 13,238 12,243 13,614 Other Assets (631) (817) (817) (817) Total Assets 29,172 31,713 35,185 39,151 Quarterly Financials Y/e March Q2FY16 Q3FY16 Q4FY16 Q1FY17E Net Revenue 11,977 11,469 10,654 11,290 EBITDA 2,007 1,710 1,708 1,829 % of revenue Depr. & Amortization Net Interest Other Income Profit before Tax 2,405 2,072 2,013 2,227 Total Tax Profit after Tax 1,986 1,784 1,642 1,826 Adj. PAT 1,986 1,784 1,642 1,826. July 15,

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