Cummins Incorporated (CMI) reported a fabulous fiscal fourth quarter prior to the market’s open on Tuesday that caught nearly everyone off guard in just how strong it was. The engineering firm and North America’s largest maker of heavy-duty engines benefited from robust demand for diesel engines from emerging markets, as well as the effect of new legislation that became law in January. The legislation toughens emissions standards and trucking firms tried to buy the older, cheaper engines before the changes took effect.
In the fourth quarter, net income increased to $270 million or $1.36 per share versus last year $43 million or $.22 per share. The consensus analysts’ estimates, based on 16 different projections, called for only $.76 per share, with the highest among them at $.90. Sales outpaced estimates of $2.83 billion and 12% growth in engine sales propelled overall revenue to come in very strongly at $3.4 billion. Shares are surging ahead more than 9% in afternoon trading on the major earnings surprise.
However, Cummins management warned that the first half of 2010 will be “extremely challenging” and
said shipments may fall as much as 80%. We wrote a piece on Cummins in early December (Jobs Leaving at Cummins) when the company announced that it will be curtailing operations at its Jamestown Engine plant in anticipation of slacking demand following the emissions standard change. At that time, management speculated that engine demand could fall from 500 per day to just 100 per day. It is clear that Cummins will need to see continued strength from emerging markets in order to ease the pain of sluggish domestic sales.
There is no doubt that the past quarter was an exceptional success for Cummins, but we are concerned about the stock’s valuation and currently have it as Overvalued. Despite the company’s declaration that the first half of the year will be exceptionally weak domestically, analysts’ projections appear somewhat bullish on the second half of the year. Additionally, the stock is trading well above its historically normal valuation ranges. For example, price-to-cash earnings has normally been between 5.1x and 13.0x, but it is currently nearly 17x. Also, price-to-sales per share has ratcheted up to .85x, meanwhile over the last ten years it has normally been between .32x to .78x. Clearly, we are skeptical that the stock can maintain this lofty valuation, especially considering the difficult operating environment that it is in now. Congratulations are in order for the blowout quarter, but we think investors may be left with a hangover when the party ends.
