Cummins (NYSE: CMI) is a global leader in diesel engines, and it has been an investor favorite over the past decade, with its shares putting together more than 10 times the growth of the S&P 500:
CMI Total Return Price data by YCharts.
But does that mean that Cummins investors can sit back and relax as their shares increase in value for years to come? We'd like to hope so, but there might be some big roadblocks between Cummins and its goals. We recently looked at several reasons why Cummins shares might keep gaining, but it's important to consider all the angles of a stock before diving in. Let's dig deep into Cummins today to find some threats to its continued success and determine if they're enough to keep its shares from growing in the future.
Cummins is losing sales in its critical engine segment
Cummins' engine segment accounts for roughly 60% of its revenue in any given year, which makes its performance vital to the company's continued success. Sales spiked after suffering through the recession, but have declined in each fiscal year since 2011:
|
Year |
Engine Segment Revenue |
Year-over-Year Growth Rate |
|---|---|---|
|
2010 |
$7,888 million |
18% |
|
2011 |
$11,307 million |
46% |
|
2012 |
$10,733 million |
(5%) |
|
2013 |
$10,013 million |
(7%) |
Sources: Cummins annual reports.
Cummins still expects engine segment revenue in the 6% to 8% range this year, but that would merely bring that segment back in line with its position in 2012.
The company has enjoyed rapid growth in China over the past few years, but executives noted in their latest quarterly conference call that industry demand for heavy- and medium-duty trucks dipped by 10% in the second quarter, with significant softening in year-over-year demand in May and June (11% and 20% lower, respectively). China is Cummins' second-largest market after the U.S., and the country accounted for 7% of the company's total revenue last year, so any prolonged sales weakness there would have a large impact on Cummins' performance.
Several of the truck makers that comprise the bulk of Cummins' engine sales are also shifting toward more in-house engine production, and other truck makers that have historically focused on building their own engines are gaining share in the overall truck market.
Volvo, which primarily uses its own engines, and its Mack truck subsidiary, which exclusively features in-house engines, grew their combined market share to 17.5% last year, up from 16.5% a year earlier. PACCAR (PCAR +0.02%), which has long been a major user of Cummins engines, accounted for 7.9% of the engine market in 2013, up from just 5.2% the year before. PACCAR's MX line of engines claimed 35% of the North American market for 13-liter engines, according to company executives during their latest conference call. The company is targeting 50% share in the MX's engine classes, which certainly poses a threat to Cummins' continued growth if PACCAR's move toward more in-house engine production accelerates.
Truck sales are already at multiyear highs
Cummins' fundamentals have boomed and its shares have tripled over the past five years as the trucking industry slowly but steadily recovers from the financial crisis. In fact, Cummins' growth matches rather closely with the overall growth of heavy- and medium-duty truck assemblies (new units built) over the past five years:
US Heavy and Medium Truck Assemblies data by YCharts.
Why is that a risk? Well, the automotive industry, particularly commercial truck manufacturing, is sensitive to economic shifts, and no economic expansion can continue forever. The truck assemblies statistic dates to the late 1970s, and while the most recent period of expansion still records significantly fewer units than the pre-crash period, it's also one of the longest periods of uninterrupted volume growth in more than 30 years:
US Heavy and Medium Truck Assemblies data by YCharts.
On the plus side, history shows that the truck assemblies statistic has historically been well on its way to a bottom by the time recessions are officially declared, and the current period of expansion shows no sign of reversal yet. But even the roaring '90s endured a stretch of declining volume, so unless this time really is different, Cummins could find itself at the mercy of macroeconomics in the near future.
The transportation industry could be in for a real transformation
Commercial transportation today is more or less the same as trucking 50 years ago. Routes might be mapped by computers and shipments tightly controlled by algorithm, but the basic outlines of getting stuff from point A to point B haven't changed since entrepreneurs realized that the nation's highways were a great way to move goods. That might change in the next few years in ways that could devastate Cummins' core business.
Electric vehicles have received a great deal of attention, but virtually all of it has been focused on the consumer side. There's a good reason for that: Trucks and other heavy-duty vehicles are on the road for long hours, pulling large loads, while the typical car owner drives less than half an hour at a time and might never haul anything heavier than a load of groceries. Thus far, all efforts to develop commercial transportation on an electric drivetrain have failed. But battery-powered commercial transport is bound to get a big push as electric successes from Tesla Motors (TSLA +0.73%) and other well-known manufacturers establish the viability of electric transportation in the public mind. This is years down the line, but it could be a long-term threat to Cummins' internal-combustion engines.
Cummins is already developing alternative-fuel engines with Westport Innovations (Nasdaq: WPRT), but slow adoption rates for these natural gas engines -- Westport's shares recently crashed on underwhelming growth guidance -- show the clearer near-term challenge in moving the world away from its reliance on diesel fuel for truck-based transport. Cummins could also branch out into EV development on its own, but this is an area where it has no technological expertise and no clear path forward. The company's move into nat-gas engines was a natural extension of its work on diesel engines, but it's yet to show a similar interest or aptitude in EV development.
Self-driving vehicles are another significant long-term danger to Cummins' growth. While this might not seem to be a problem, one simply has to consider the limitations of human-driven trucks to see why an automated trucking fleet would dent Cummins' bottom line. I've written about self-driving cars before, and the general consensus among those who have analyzed this technology's potential is that it would likely result in far fewer vehicles on the road.
Trucks today are limited by the ability of their human drivers to navigate large containers full of goods down busy highways. To protect truck drivers and other drivers on the road, the government has lately been implementing several tough restrictions on truckers' work, including a mandate for speed limiters on large trucks, and a workweek restriction that forces truckers to drive no more than 60 hours per seven days and to take 34 hours off if they reach this limit earlier in the week. Truck designs must also take human sensory limitations into consideration.
Trucks that drive themselves would have no such restrictions -- a self-driving truck could be on the road 24 hours a day, seven days a week, and could haul multiple trailers that could individually adapt to road conditions as necessary. That would mean that fewer trucks, and thus fewer Cummins engines, would be on the road at any given time, since the entire trucking fleet could operate at maximum efficiency. Trucks are in use far more often than cars, but even so, it's worth considering that even the most dedicated truck drivers in the United States are only allowed to be on the road for 40% of the hours in any given week. If every truck were active the other 60% of the time, we wouldn't need as many of them to handle the same amount of shipment volume.
If self-driving trucks become a reality -- and the arguments against this continue to dwindle year by year -- Cummins' business would be at real risk. This threat is the most distant among those cited in this article, but it's also potentially the most dangerous.
Three good reasons?
Two of these risks pose a near-term threat to Cummins' continued gains, but the third risk, while set farther in the future, could present an existential threat to a company that was built around an engine that rose to prominence more than a century ago. Cummins has weathered economic downturns many times before, but it has never yet faced a technological challenge that could actually usurp diesel engines as the prime mover of commercial transportation. Will this risk be enough to hold shares down, or will Cummins find a way to thrive in a new transportation reality, whatever that reality might look like in the end?
