This article has been updated on October 30, 2014.
I'm going to attempt something a little odd today, Fools. Even though I recently bought shares of engine-maker Cummins (NYSE: CMI ) I'm going to be giving you three reasons to consider selling Cummins stock today.
Why am I doing this?
Recently, Nobel Prize winner Daniel Kahneman visited Fool headquarters in Virginia. While visiting, he talked about how a number of different biases can lead us to believe that we can predict the future with relative certainty. In reality, he argued, we are just deluding ourselves.
It got me to thinking about how I don't write enough about the risks of owning the stocks I own. So, though I don't plan on selling my Cummins stock right now, I think it's healthy for me to practice and model this behavior.
1. Big slowdown in emerging markets
Many investors in Cummins are hoping for the company to grow its presence in Brazil, China, and India. As those countries build out their infrastructures, there will be continued demand for trucks and machinery. If a Cummins engine can find its way into those trucks or pieces of heavy machinery, it would have a significant effect on the company's revenue.
In 2012, however, there was a noted slowdown from these emerging markets. While that slowdown reversed itself somewhat in 2013 for Brazil and China, overall numbers in the emerging markets are still noticeably lower.
It's important to note that while these three countries combined account for only 16% of total revenues in 2013 – they are an important part of many investors' vision for Cummins.
2. Customers decide to go in-house
While Cummins makes a dizzying variety of engines, it doesn't make any of the vehicles that actually use the engines. As the company states in its annual report: "PACCAR, Volvo AB, Navistar International Corporation and Chrysler, are truck manufacturers or OEMs that manufacture engines for some of their own products...[but] have chosen to outsource certain types of engine production to us."
The business from PACCAR (NASDAQ: PCAR ) in particular, is important to Cummins. In 2013, PACCAR accounted for 12% of Cummins' consolidated net sales. If any of these companies were to switch to a different engine maker, or choose to make their own engines in-house, it would likely cause a noticeable decline in revenue.
3. Differing emissions standards and demand
One of the huge advantages to investing in Cummins is that it exposes you to a company that is on the cutting edge of low-emissions engines. Cummins has worked to develop engines that comply – and go above – EPA, European Union, and California Air Resources Board specifications.
It has also partnered with Westport Innovations (NASDAQ: WPRT ) to offer natural gas engines.
But there are several threats stemming from Cummins' significant investment in low-emissions technology. The first could be that different regulatory agencies don't put in place or enforce new environmental standards.
The second is that the standards could start to deviate significantly – with the EPA requiring one thing, and the EU something entirely different. That would cause Cummins to spend even more of its resources on tailoring the engines, instead of ramping up production to a level of scale.
A third, very different type of threat could come from the fact that demand for these engines might not be as strong as you'd expect. Indeed, in January this year, Cummins decided to hit the pause button on its in-house 15-liter natural gas engine. This came after a similar engine made though the Cummins-Westport JV discontinued manufacturing due to low demand.
What's a Fool to do?
As it stands right now, I'm definitely holding my shares. Emerging markets may be a drag on Cummins stock for a while, but I have a decades-long timeline. While losing PACCAR would be a heavy hit, the two companies have been doing business for 68 years, and I don't see any news to make me think that relationship is coming to an end. And while I can't foresee how environmental regulations will play out, I'm confident with Cummins' market position in that respect.
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