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3 Reasons Cummins Stock Could Fall

By Travis Hoium - Jan 27, 2016 at 4:34PM

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A lot of headwinds face Cummins Inc. in 2016.

The end of 2015 wasn't great for Cummins (CMI -0.63%) -- third-quarter revenue dropped 6% and net income fell 10%, both hurt by weak international demand and a strong dollar. Management responded by slashing its workforce to keep costs in line with demand, signaling that more declines might be ahead.

The downward trend in earnings was only overshadowed by the drop in the share price during 2015. For investors looking into Cummins today, there are three concerns to watch in 2016 to make sure there's not even more downside coming.

CMI Chart

CMI data by YCharts.

International sales continue to tank
Sales outside of North America fell a whopping 18% in the third quarter, and if that trend continues, shares could continue their dive. For years the international market was seen as a growth opportunity for Cummins, but right now it's a liability. 

There are two major concerns to watch in 2016. First, the strong dollar makes international sales look smaller than they are in local currency, so that could impact sales growth, although there isn't much management can do to solve that problem. More concerning is the company's demand, particularly in China and Brazil. If both economies continue to slow in 2016 it could lead to another rough year. 

The U.S. goes into a recession
Sixty percent of Cummins' sales come from the U.S. and Canada, which has helped the company remain solidly profitable while international markets turned south. But there's no guarantee that trend will continue. The last time revenue and earnings took a big decline was during the last recession, making North America an economy worth watching.

CMI Revenue (TTM) Chart

CMI Revenue (TTM) data by YCharts.

Out of all of Cummins' risks, I think this is the lowest. Low energy prices will have a positive effect on the U.S. consumer and businesses, which should keep the economy rolling. Even a shallow recession shouldn't have a huge impact on demand, but it's something for investors to watch.

Commodity prices stay suppressed long-term
A lot of what Cummins sells is affected by commodities in one way or another. Mining, shipping, drilling, and industrial processing are just a few ways in which Cummins engines are used, and they're all affected by the drop in commodities, from oil to steel.

In some cases, the decline in commodities can be a good thing. But broadly, it's bad for Cummins' demand long-term. If commodities stay depressed, I would expect that off-highway and power-generation businesses will continue to suffer. Engine sales fell 10% in the third quarter because of weakness in these markets, and power-generation segment sales dropped 13% in the quarter. Continued weakness in commodities could drive sales even further south.

The upside for Cummins shares
There's a lot of macro risk for Cummins in 2016, but management has reduced expenses to the tune of $160 million-$200 million in anticipation of weak demand, and a lot of poor performance is already priced into shares. The stock has a trailing P/E ratio of just 8.7 and a dividend yield of 4.5%.

At that price I think the risks are worth the potential reward, and that this is an industrial stock poised for recovery in 2016.

Travis Hoium has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Cummins. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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