After years of poor performance, the industrial sector of the economy is finally starting to bounce back. Greater levels of activity in key areas like construction, infrastructure, and natural resources have plenty of positive implications for engine specialist Cummins (CMI +6.06%). Shareholders have anticipated that a rising emphasis on infrastructure improvements would lead to better performance from Cummins, and those expectations have helped send the stock sharply higher over the past year despite more measured commentary from company executives about the speed at which the industry will recover.
Coming into Tuesday's second-quarter financial report, Cummins investors wanted to see significant gains in earnings and sales from the engine maker. The company was only able to deliver a positive surprise on its top line, falling short on the net income front and disappointing shareholders in the process. Let's look more closely at Cummins and what its latest report says about what's happening with the company.
Image source: Cummins.
Cummins sees sales soar
Cummins' second-quarter results were mixed. Revenue jumped by 12% to $5.08 billion, which was roughly double the growth rate that most investors had expected to see. Net income growth was more muted, rising just over 4% to $424 million, and the resulting $2.53 per share in earnings compared unfavorably with the consensus forecast among those following the stock for $2.56 per share.
Looking more closely at Cummins' numbers, the company enjoyed better demand from key parts of its customer base. Higher demand for trucks and construction equipment in China and North America was one driver of higher sales for Cummins, as was better sales performance for its mining and oil and gas customers. Geographically, Cummins saw balanced contributions from various regions, with a 13% rise in North American sales topping the 11% growth in international sales, which hinged on contributions from China and India.
Cummins' segments had very similar revenue performance. The engine segment led the way with 15% sales growth, with off-highway revenue climbing 20% due to construction market rebounds. The components division saw a 14% rise in sales, centered on China and India, which powered a 25% gain in international revenue for the segment. Distribution unit sales were up 12% due in part to recent acquisitions, and the power systems division posted a 10% gain from mining and energy demand.
From a profit perspective, things were more mixed. Engine segment pre-tax earnings soared by more than a third, and distribution added about a 10% rise in pre-tax profit. However, the components division was flat on the bottom line, and power systems segment pre-tax earnings fell by nearly a third due to costs associated with an internal quality campaign.
What's ahead for Cummins?
CEO Tom Linebarger was quite pleased with the breadth of Cummins' success. "We delivered strong revenue growth in all four operating segments in the second quarter," Linebarger said, "due to improving conditions in a number of important markets where we also have leading share." The CEO did note that higher warranty costs ate into earnings growth.
Because of improving conditions, Cummins increased its sales guidance for 2017. The company now expects revenue gains of 9% to 11%, up from the 4% to 7% range announced last quarter. However, Cummins didn't change its pre-tax profit margin expectations, keeping them at 11.75% to 12.5%. Higher sales with the same margin should produce greater absolute earnings, but Cummins failed to send the positive message that it did in the first quarter with both top-line improvement and a rise in projected pre-tax margin.
Cummins investors weren't happy with the weaker-than-expected earnings results, and the stock dropped 6% in the opening minutes of trading following the announcement. With the share price having nearly doubled since the beginning of 2016, it's reasonable that even a small disappointment would be enough to send Cummins stock lower. Fundamentally, though, Cummins might be seeing just the beginning of a more impressive move higher for the business.
