Cummins (NYSE:CMI) investors received an early Christmas gift this Monday when Bank of America Merrill Lynch initiated coverage on the stock, rating it a buy with a price target of $158 a share. That represents a good 18% upside from the stock's current price of around $134.
But what's important to note is the time frame -- BAML believes that Cummins will hit $158 within the next six to 12 months. In a way, that suggests that 2014 will be a much stronger year for Cummins, since the stock has returned just about 17% so far this year. While I usually don't go by analyst targets, I think investors have a solid reason to take BAML seriously on this one.
Why 2014 is a critical year
BAML is primarily betting on stricter emission regulations to fuel Cummins' growth in the near future. With nearly every country pushing for stringent environment regulations, Cummins could be a major beneficiary. From that standpoint, 2014 is a significant year, with several important emission regulations kicking off across the globe. Prominent ones include:
- U.S. Environmental Protection Agency or EPA's greenhouse gas emissions (GHG) program
- The European Union's Euro VI emission norms for heavy-duty vehicles
- China's NS IV emission standards
- EPA's Tier 4 final standards
- EU's Stage 4, covering diesel engines between 56 and 560 kW.
A TIME report has even touted 2014 to be the "year of the diesel engine," what with leading auto makers increasingly offering the diesel option in their cars, SUVs, and trucks. Industry experts even expect the number of diesel cars to more than double over the next one year. Naturally, as a leading innovator and the world's largest diesel-engine maker, Cummins stands to be the major beneficiary of this diesel drive.
The company's strength lies in its "fit-for-market" strategy, under which it designs and customizes engines and components to suit a region's specific requirements. That may explain why Cummins' engines are sought after not only in the U.S. but also in key global markets like India, Brazil, and Russia. The company enjoys more than 30% of the on-highway truck market share in each of these nations and more than half of its total revenue in 2012 came from markets outside the U.S.
The big opportunity
China, in particular, looks like a big opportunity for Cummins for 2014 because it's unlikely that the country will further delay the implementation of the NS IV norms. As the world's largest GHG emission emitter, China is under tremendous pressure from environmental activists, and its government has a lot of work to do to achieve its ambitious goal to reduce carbon dioxide emissions per unit GDP by 40% to 45% by 2020.
Since Cummins currently has only 10% of the Chinese on-highway truck market share under its belt, its emission-compliant advanced engines can act as a solid tool to strengthen foothold. In fact, I think Cummins should use its long-standing partnership with the leader in natural gas technology, Westport Innovations (NASDAQ:WPRT), to its advantage to capture the Chinese truck market.
Westport Innovations has a joint venture with China's largest heavy-duty engine maker, Weichai Power, which has done tremendously well this year: Shipments and revenue from the venture surged 133% and 126%, respectively, for the nine months ended Sept. 30, 2013. That signals the massive potential for fuel-efficient engines in China, and Cummins certainly has what it takes to exploit this massive opportunity.
Win-win for Cummins
In the U.S., too, the call for a cleaner environment and lower natural gas prices is encouraging large fleet operators to shift to natural gas. For Cummins, it's a win-win situation. While its diesel engines provide greater fuel economy at a reasonable cost, Cummins-Westport natural gas engines have emerged as the No. 1 choice for those opting for the alternative fuel.
During the third quarter, Cummins-Westport's engine shipments climbed a whopping 51% year over year, partly driven by strong orders for the much- awaited 12-liter engines, the ISX 12G. Last week, Clean Energy Fuels Corp. (NASDAQ:CLNE) confirmed the uptrend when it announced a staggering 70% jump in third-quarter orders for its natural gas vehicles year over year. As the company building natural gas refueling stations across the U.S., Clean Energy has, in a way, a major role to play in boosting Cummins-Westport's business. In fact, Clean Energy Fuels especially mentioned the successful launch of the ISX 12G engines in a recent release, mentioning how orders for the new engine are expected to jump fourfold in 2014.
Even as diesel continues to rule the trucking market, the slow but steady increase in the adoption of natural gas as an alternative fuel signals huge growth potential for Cummins, especially with so many emission regulations coming online in 2014.
As the leader in the diesel-engine market, as well as the natural gas engine market through its partner Westport Innovations, I wouldn't be surprised if Cummins stock surpasses BAML's target of $158 soon. Keep a close watch on this one.