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Tax Reform Masks Supercharged Growth for Cummins

By Dan Caplinger - Feb 6, 2018 at 9:09AM

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Find out what's sending the engine maker's prospects higher.

Industrial companies often go through cyclical swings, and for a long time, Cummins (CMI 0.35%) weathered the difficulties that plagued the customers it counted on to buy its engines. With a new cyclical upturn promising better times ahead, Cummins has gotten a lot more optimistic recently, and many have hoped that it would start firing on all cylinders.

Coming into Tuesday's fourth-quarter financial report, Cummins investors expected strong gains in revenue and earnings, and they weren't disappointed with the numbers that the company put up. In fact, Cummins sees a bright future that should make some of its followers happy. Let's look more closely at Cummins and what it said about its business.

Green-colored power generation equipment in a factory setting, with a worker behind the unit.

Image source: Cummins.

Cummins puts the pedal to the metal

Cummins' fourth-quarter results once again delivered extremely strong fundamental performance in its business. Sales rose by 22% to $5.48 billion, easily beating the 16% growth rate that most investors had expected to see. One-time charges sent the company to a GAAP loss, but after making appropriate allowances for those items, adjusted net income of $503 million jumped by a third from year-ago levels. Adjusted earnings of $3.03 per share compared favorably to the consensus forecast among those following the stock for $2.67 per share.

Tax reform made a mark on Cummins during the quarter, but it should have big benefits going forward. The company reported a $777 million charge related to the new laws, reflecting the revaluation of deferred tax assets and any repatriated gains from its overseas units. However, Cummins sees significant boosts in the future from enjoying a lower tax rate.

As we've seen in past quarters, Cummins was able to see growth in a relatively balanced manner across its geographical and business spectrum. Revenue growth within North America of 22% exactly matched what Cummins brought in its international segment. Among its business divisions, the components segment did the best, with 32% top-line growth driven largely by greater commercial truck production in North America and helping to push segment pre-tax profit up 20%. The key engine segment enjoyed a 16% boost in revenue and a 15% rise in profit on the strength of off-highway vehicle demand. Power systems got greater demand from mining and energy customers that sent profit up by nearly 40% on an 18% rise in sales. Only the distribution segment saw mixed performance, with strong revenue gains led by North American markets failing to prevent a 20% drop in pre-tax profit for the unit.

What's ahead for Cummins?

CEO Tom Linebarger was pleased with Cummins' numbers. "The Company delivered strong growth," Linebarger said, "solid profitability and record operating cash flow in 2017." He also noted that substantial returns of capital to shareholders during the year met one of the company's key goals.

Yet even with the encouraging performance, Cummins acknowledged that it won't be able to keep up the pace of revenue gains that it achieved in 2017. In its 2018 guidance, Cummins predicted that revenue will rise at a 4% to 8% clip, with an increase in pre-tax operating margin of about a percentage point to a range of 15.8% to 16.2%. That's not inconsistent with what the consensus forecast among investors following the stock, but it wasn't the positive surprise that shareholders got from the fourth-quarter results.

Cummins investors appeared to be pleased with the report, although overall stock market turmoil masked any translation of that positive sentiment into share-price gains. If the new upward trend in the industrial sector continues, then Cummins could see ongoing demand increases that could keep the engine maker's fundamental prospects moving in the right direction throughout 2018.

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