Will Cummins Earnings Live Up to Recent Hype?

Image source: Cummins.

The market for trucks and heavy equipment has been sluggish for years, and engine maker Cummins (CMI -0.25%) felt the brunt of the downturn during late 2014 and 2015. Yet as calls for a possible recovery in the global economy have gotten louder, investors have gotten more optimistic about Cummins' long-term prospects. As Tuesday's release of its first-quarter financial report approaches, Cummins investors will want more evidence that earnings and revenue can break out of their slide and start climbing once again. Let's take an early look at Cummins and what we're likely to see in its quarterly results.

Stats on Cummins

Data source: Yahoo! Finance.

Can Cummins earnings bounce back?
In recent months, investors have kept cutting their estimates on Cummins earnings. The reduction in first-quarter projections amounts to a nickel per share, but more extensive downward revisions for the full 2016 and 2017 years amount to 5% to 6%. Yet the stock has gone through an impressive turnaround, climbing almost 40% since mid-January.

Part of what started the bullish move was Cummins' fourth-quarter financial report, which sent the stock up 7% the day of the release even though the company's numbers were weak. Sales were down 6%, and net income dropped by almost two-thirds compared to the year-ago quarter. Even though much of that came from an impairment charge, adjusted earnings fell short of expectations. Strength in the U.S. dollar held back Cummins' international results, but even worse news was that the North American market also posted slight declines on the top line. CEO Tom Linebarger pointed to ongoing weakness in Cummins' end markets in justifying the decline, and Cummins' guidance for 2016 was equally poor, projecting further sales declines of 5% to 9% and deterioration in operating margins.

Yet bullish investors have continued to see the long-term potential in the engine maker's shares. Cummins has managed to keep its revenue from the Chinese market unchanged even under considerable economic pressure in the emerging-market nation. Market-share gains and an outlook that suggests that demand could be bottoming out have investors excited about prospects in China, as well as decisions from local manufacturers to replace older engines with products from Cummins' joint ventures there.

Moreover, Cummins is setting itself up to be in an even better position once the industry starts turning around. The company's financial condition is solid, with a steady balance sheet. A commitment to returning capital to shareholders through dividends and stock buybacks has grown stronger, and Cummins has said that it looks to return about three-quarters of its operating cash flow this year to investors through these two methods. Cost containment measures have helped support Cummins' financial strength, but they'll also pay off with a leaner business model even once economies start to improve.

Nevertheless, Cummins still faces challenges. Some makers of trucks and heavy machinery have made moves toward vertically integrating engine manufacturing under their own roofs, and that could pose a competitive threat to Cummins. Moreover, market share for heavy-duty engines in North America has fallen recently, and the plunge in demand for off-highway engines for the mining, oil and gas, construction, and agricultural industries will keep Cummins under pressure until conditions in those industries get better. The company recently decided to scale back on light-duty engine manufacturing for the North American market because of weaker market conditions there as well.

In the Cummins earnings report, investors will need to see signs of a long-term recovery in order to justify the huge share-price gains the stock has seen in recent months. Otherwise, Cummins shareholders could be in for a shock.