Leading truck engine maker Cummins (CMI 0.64%) has driven decent long-term returns for investors. Over the last three years, the stock has outperformed the S&P 500's 55% gain, rising 67%.
Yet Cummins has lost traction in 2021 because of the computer chip shortage that has impacted all vehicle manufacturers and most other industries. Shares trail the index by nearly 16 percentage points year to date. With the stock down 13% from the all-time high hit back in March, the engine maker appears undervalued given how it should perform in the years ahead. Here's why.
Image source: Getty Images.
Getting back on the road again
Last year was one most companies and investors would like to forget, but the lingering effects of the pandemic continue to be felt today. Beyond the chip shortage, supply chain disruptions have yet to sort themselves out, meaning Cummins' own production and manufacturing capabilities will feel the pinch.
The engine maker, however, is looking for robust growth this year, recently reiterating it expects revenue to expand 20% to 24% over 2020, which ought to put it ahead of where it was two years ago before the world turned upside down. It also anticipates margins for earnings before interest, taxes, depreciation, and amortization (EBITDA) to be in the 15% to 16% range, which again is at or above pre-pandemic levels.
This indicates Cummins' business was only temporarily impacted and should continue on its growth trajectory.
The future is alternative fuels
As strong as the diesel engine market is proving for Cummins -- and it will be the primary energy source for the trucking industry for years to come -- it is nonetheless changing every bit as much as the automotive market. Heavy trucks will increasingly utilize alternative fuel sources, and the company has jumped into the market with both feet, establishing itself as a leader in hydrogen fuel cell technology, as well as in battery and natural gas.
Its new power segment is already targeting the urban bus market and school bus market in North America. The segment is also powering commuter trains in Europe with its fuel cell capabilities, and it has begun testing a hydrogen-fueled internal combustion engine. If successful, Cummins can provide the market with a near-zero emissions engine that also considerably lowers its cost of retooling.
Image source: Cummins.
Partnering for growth
This past quarter, Cummins also agreed to form a joint venture with Rush Enterprises (RUSHA 1.07%) to produce Cummins-branded natural gas fuel delivery systems for commercial vehicles, and Air Products & Chemicals (APD 0.16%) is working with the engine maker to convert its fleet of 2,000 trucks to hydrogen fuel cells.
Cummins is also working with Clean Energy Fuels (CLNE 3.83%) to get trucking companies to convert to natural gas engines, with the renewable natural gas provider noting Cummins' natural gas engines perform as well as their diesel counterparts, but with 90% fewer tailpipe emissions.
Cheap, clean growth
Remember, even with all the leadership capabilities Cummins is demonstrating in alternative fuels, its diesel engines will still be its main growth driver, and that is looking healthy, too.
Diesel engines are more efficient than gas engines and they can last longer due to less wear. Cummins believes that gives the diesel engine market a much longer tail than many expect.
Investors can enjoy that growth, plus the gains it makes as Cummins helps companies convert to other fuels. In addition to a cheap share price, it pays a dividend yielding 2.3% annually that it has raised for 11 consecutive years.
Cummins stock trades at 16 times trailing earnings and just 12 times next year's estimates, and it's being offered at a discount to Wall Street's long-term earnings growth rate. At 17 times the free cash flow the engine maker generates, while it's not in the basement bargain bin, Cummins is an undervalued stock you can buy today.
