Cummins responds to rising costs

Analysts pound the engine maker for some margin losses, raising questions about cost management.

By Jim J. Jubak Feb 2, 2011 6:31PM
Jim JubakJust goes to show you that Wall Street can find a problem in any earnings report -- if analysts really want to.

Before the market opened yesterday, Cummins (CMI) reported fourth-quarter earnings of $1.84 a share (12 cents above an analyst projections) and revenue of $4.14 billion (above the $3.92 billion analyst projection), and it raised guidance for 2011 to $16 billion (above the $15.94 billion consensus).

For the quarter, the company’s engine, components, and distribution segments all reported record sales. For 2011, Cummins forecast a 25% increase in sales for its engine and component units and a 15% increase in its power-generation and distribution units. Demand from Brazil, China, and India was a key part in setting sales records, with 37% growth in India and 70% growth in China and Brazil. (International sales now account of 64% of total sales, up from 40% in 2000.)

But was Wall Street totally happy? No way. Analysts nitpicked the company’s margins.

The company’s operating margin climbed to 13.1% for the fourth quarter, up from 11.4% in the fourth quarter of 2009, but -- ready for the bombshell? -- margins in some business segments didn’t match sales growth. In the truck-engine business, for example, sales rose 21% from the third quarter, but operating margins plunged to 10.3% from 10.8%. In the power-generation segment, sales rose by 14% from the third quarter but operating margins dropped to 10.2% from 12.3% in the third quarter.
 
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Now, I understand what analysts were getting at: These declines in margins might be a sign that the company is letting costs get out of control.

I thought chief executive Tim Solso and Chief Financial Officer Pat Ward had a very good answer for that question during the conference call. Yes, they noted, commodity costs (steel, aluminum, rubber, etc.) were on the rise but, thanks to its market share, the company would be able to pass on at least some of these higher costs through a 1% increase in the price of its engines in 2011. Cummins has nearly 50% of the U.S. engine market, according to Morningstar, and its 2009 win at Daimler gives the company an increased profile in Europe.

I think we’re still early in the truck replacement cycle, and the power-generation unit is really just starting to rebound. I’d be a buyer of Cummins at the current price of $106.47 or (even better) on any weakness. As of Feb. 2, I’m keeping my target price for Cummins in my Jubak’s Picks portfolio at $136.

At the time of this writing, Jim Jubak didn't own shares of any companies mentioned in this post in personal portfolios. The mutual fund he manages, Jubak Global Equity Fund (JUBAX), may or may not own positions in any stock mentioned. The fund did own shares of Cummins as of the end of December. For a full list of the stocks in the fund as of the end of the most recent quarter, see the fund's portfolio here. 

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