How to Profit From Manufacturing's Ongoing Revival

With 2013's third quarter drawing to a close, there are signs of resurgence in manufacturing, agriculture and automobile sectors. China is said to be on track to outdo its estimated GDP  performance that was put forward by economists, with growth primarily coming from domestic demand rather than exports.

While stimulus packages for rail, tax cuts, and monetary stability are all adding up to help China's GDP, its construction industry is still in the doldrums. A recent report by a management consulting and investment banking group shows an underperforming construction industry for the third quarter, which will benefit only from health care and manufacturing construction in 2014.

More importantly, China's construction industry will continue to suffer throughout the remainder of 2013 amid negative sales and net profit declines. Perhaps this is why the world's largest mining and construction equipment provider, Caterpillar (CAT 1.58%), has introduced a short-term incentive plan, the centerpiece of a profit-sharing program.

As its global retail machine sales continue to decline, the company will decrease its outlays significantly by the new plan's introduction. It has faced a 10%  year-on-year decline and 9% quarter-on-quarter decline through the months of June, July, and August. For the remainder of 2013, Caterpillar has slashed its inventory by more than $1 billion to cut back on machinery which just won't sell. Based on China's PMI  which has hit a 17-month high, however, there is a clear indication of improvement in the region. Caterpillar's slowdown in growth was greatly affected by the Chinese slowdown, and the company now has an opportunity to claw its way back on the stock market.

In North America, there is a very different type of boom going on in the agriculture and automotive industries. On the agriculture front, net farm income by the end of 2013 is forecasted to grow by 6% over 2012 figures. If Deere's (DE -0.60%) 26%  quarterly profit is anything to go by, I would say agriculture is leading the financial recovery in the U.S..

Deere has a firm footprint that allows it to expand from its core U.S. market into Russia, China, and most recently Latin America, where future growth is likely to come from. The company's underlying growth themes can be summarized with the simple aspect of population growth. The company is launching fuel-efficient and higher-horsepower models of its tractors in an attempt to woo farmers. For the remainder of 2013 and the incumbent 2014, increases in farm asset values are expected to exceed increases in farm debt; this will increase disposable income for farmers which is expected to renew the demand for farm products.

While car manufacturers are understandably cashing in on the automotive boom, there is now a new entrant into the sector – Cummins (CMI 0.79%). The company is introducing a broad variety of on-highway and off-highway heavy duty engines  which will be compliant with the latest emissions requirements. This is a precursor to seeing Cummins' diesel engines in full-sized trucks and machinery. Toyota and Nissan are already mulling over the use of Cummins engines for their Tundra and Titan models, respectively, while Navistar is also offering Cummins engines in medium duty trucks and buses.

Performance and Metrics

Source: Yahoo! Finance 

At a time when uncertainty and below-par performance has plagued the share prices of Caterpillar and Deere, Cummins has had a 45% appreciation in its price from a year ago. Cummins has a large market share in the U.S. and Canada due to the vast number of engines installed in Navistar's vehicles. The introduction of newer engines will only help Cummins improve the percentages.

Cummins' superiority over its peers continues to impress, as its above-average revenue and income growth over the past three years shows the organic aspects of its growth. Furthermore, compared to Caterpillar and Deere, Cummins has negligible debt – this not only encourages investor confidence, but also allows the company to seek external financing for investments into research and development.

Unfortunately, Cummins is expensive at its current share price. The downside also continues on the dividend front as its peers provide higher yields. Its growth prospects and further share price appreciation are profound and lucid, however.

Why Cummins

Confidence in Cummins is high and the company's performance has been phenomenal over the course of 2013. At a time when the company is launching new products and faces increased demand from mass-scale vehicle producers, there is very little threat of Cummins' share price performance being derailed. As long as Cummins feeds off the automotive revival, Caterpillar and Deere will continue to be overlooked.

On the other end, Caterpillar has been facing difficult macroeconomic conditions globally; while there is no question about the company's ability to make quality products, it is currently going against the tide, which makes it extremely difficult to achieve huge margins, and its fundamentals don't live up to the competition's.

Deere could potentially be tipped for 2014 if crop yields manage to improve on the current level, but since weather is perhaps an investor's least friendly variable, that's a high-risk maneuver. It makes sense to invest in Cummins instead; its business is expanding rapidly, and it also has stock market performance and solid financials to back up the claim.

Bottom Line

The auto industry's demand is expected to grow significantly in 2014. As Cummins expands the number of engines being offered to customers, investors may want to look closer at whether now's the time to take advantage of the company's potential.