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3 Reasons Cummins Stock Could Rise

By Dan Caplinger – Mar 5, 2016 at 8:30AM

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The engine-maker has struggled, but a turn in some key industries could help the company rebound.

Image: Cummins.

Engine-maker Cummins (CMI 0.20%) has struggled under the weight of a misfiring global economy, and its stock has paid the price, falling 29% over the past year. Yet even though the company has been down and out lately, Cummins has a lot of long-term potential and is just waiting for a turnaround in some key industries to help its stock recover lost ground. Let's look at three of the key factors that could push shares of Cummins higher.

1. Distribution and components have performed better than the engine segment.
Most of the attention that Cummins has gotten has focused on its engine-making division, which is its largest in terms of sales. However, even though it has performed quite badly, other parts of Cummins' business have done better and could lead the company out of its slump if they can remain strong.

For instance, the distribution segment reported a 1% gain in revenue during the fourth quarter of 2015, easily outpacing the 11% drop in the engine segment's sales. Pre-tax profits slumped to $111 million, but the drop was less severe than the 40% decline that Cummins' engines suffered. Similarly, sales of components were down 6%, but segment pre-tax profit actually increased by nearly 10% for the quarter. If components and distribution can outperform engines in key metrics, then Cummins could get the support it needs to outlast a cyclical downturn hitting the engine segment.

2. Recovery in key emerging-economy markets like Brazil and China.
Throughout the industry, poor conditions in emerging markets have hit makers of heavy industrial equipment for a loop. Caterpillar (CAT 0.19%) is still reeling from the impact of sluggish global economic activity, with its exposure to the energy, mining, construction, and infrastructure industries creating plenty of pressure on Caterpillar's results. Cummins is also dealing with tough conditions in Brazil and China, where a combination of negative currency impacts and poor levels of economic activity are contributing to less than ideal sales.

The key for Cummins to rebound in these areas is for the local economies to start to hit bottom and regain some of their lost confidence. For example, in the most recent quarter, the components segment included positive news from China, where revenue for components increased. Power generation growth in India also helped boost the company's overall results. All in all, emerging markets have played a major role in powering Cummins' ascent, and the company needs to find ways to stay prepared to serve those markets when they power back up.

3. Macroeconomic conditions might not face a worst-case scenario.
Added to all the uncertainty about Cummins' international markets is the fact that many analysts now question whether the recent strength in the U.S. economy will continue. Already, Cummins has seen some declines in heavy-duty truck production in North America, and stronger demand for medium-duty trucks and bus production in Cummins' home territory were able to offset the heavy-duty weakness only partially. Similarly, in the components segment, reduced sales in on-highway markets in North America contributed to the unit's overall weakness, and a 12% drop in domestic Power Generation revenue further underscored concerns.

Yet despite fears of global contagion, the U.S. economy has remained resilient. The share-price declines that Cummins has already seen incorporate the weakness in the company's home markets, but there's no reason necessarily to assume that conditions close to home will deteriorate further. Cummins' own outlook incorporates a near-worst-case scenario, and its outlook is fairly cloudy. That's left Cummins in a good position to provide positive surprises if anything other than the worst of news comes out.

Cummins has convinced investors that conditions will be tough for a long time. That has left the stock in a position in which it has almost nothing to lose and a lot of potential upside. That's a situation that investors should like about Cummins and could support share-price gains if even a hint of improvement comes through in 2016.

Dan Caplinger has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Cummins. 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.

Stocks Mentioned

Caterpillar Stock Quote
$236.13 (0.19%) $0.44
Cummins Stock Quote
$249.75 (0.20%) $0.49

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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