Should you worry about fourth-quarter warnings?

Shares of Cummins dropped briefly on reduced fourth-quarter guidance, but investor optimism returned.

By Jim J. Jubak Oct 27, 2011 5:11PM
All those warnings about weakness in the fourth quarter are starting to sound like a pattern. At least I'm starting to see investors and analysts leap to work building a pattern.

Be careful, though -- the warnings are coming from very different directions, which should make it hard to draw larger conclusions about market sectors and the global economy.

Let’s take the Oct. 25 poster child for fourth-quarter warnings, Cummins (CMI). (Cummins is a member of my Jubak’s Picks portfolio.)

That day, Cummins announced third-quarter earnings of $2.35 a share, beating the Wall Street consensus by 11 cents a share. Revenue fell by 0.3% from the third quarter of 2010 and, at $4.63 billion, came in short of Wall Street projections of $4.62 billion.

But what sent the stock down for the day by more than 5% was the company’s guidance for the fourth quarter. For the full year, Cummins said revenue will be $17.5 billion to $18 billion. That’s down from the company’s former guidance of $18 billion and the Wall Street consensus projection of $18.13 billion.

EBIT (earnings before interest and taxes) margins will fall to 14% to 14.5%, from previous guidance of 14.5%. This works out to full-year earnings per share of $8.40 to $8.95. The Wall Street consensus projects $8.88 a share.

This kind of fine-tuning is worth a decline of 5%?

Absolutely -- if it’s a harbinger of a slowdown in Cummins’ business. If the company is pointing to the lower results in the fourth quarter of 2011 as an indication of a continuing or deeper slowdown in 2012, then, yes, the market’s reaction is absolutely appropriate.

Which means, of course, that you’d better take a look at why Cummins reduced its guidance.

Problems with its core North American and European truck business? Nope. Sales of diesel truck engines rose 43% for the quarter from the third quarter of 2010, on strength in the North American and Brazilian markets. Heavy duty truck engine sales grew 89% in the third quarter, and for the year Cummins guided truck revenue growth to an 86% rate.

Problems in China and India? Yep. But very limited problems. Cummins pointed to reduced demand for truck engines as its Dongfeng joint venture, as the plant works through a build up of inventory.

Demand for diesel engines for power generation from China is expected to ease in the fourth quarter. That follows on weaker demand from India in the third quarter.

But serious problems anywhere? Not unless you believe that China’s economy is headed for a hard landing in 2012, when measures from 2011 intended to slow economic growth and inflation overshoot. (Of course, if you believe that, you need to run -- not walk -- to the nearest market exit, because a big slowdown in Chinese growth -- something less than 7% -- will take down pretty much everything.)

In looking for an explanation of why Cummins decided to tweak its guidance, I think you also need to consider the effect of turnover in the CEO job. Chief executive Tim Selso will retire in January, to be replaced by Tom Linebarger, president and chief operating officer since 2008 and a 17-year Cummins veteran.

Many new CEOs tend to be extra conservative with their initial guidance, knowing that lowering targets on the old guy's watch so that the new guy can start off beating expectations is a good career move.

I think the 2012 will be a bit slower in China -- and certainly in Europe -- than I expected when I calculated a $153 target price for Cummins by March 2012. I’d trim that a bit to $145 by July.

The stock has pretty much recovered from its Oct. 25 drop...and then some. Shares rose 7.2% Thursday. That pushed the price back over $100 a share, a level that has presented an obstacle to the stock recently.

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 June. 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. 
Tags: CMIJim Jubak
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9Comments
Crying Tree
Oct 28, 2011 12:47AM
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The stock market goes up because debt is forgiven & not paid. Does it go down when bills are paid? Manipulation at its finest.
geopet
Oct 28, 2011 1:27AM
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If 1 in 10 stocks goes up. The analyst will brag about the one winner,forgetting the other nine they put into losing positions.
frankit2
Oct 27, 2011 10:17PM
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Someone told me they passed a new law,  all analyist (and their parent company's) are required to warranty and stand behind their advice and one sided predictions they "publish" for public consumpion.  Or, if their advice proves to be wrong, people that loose money because of that advice can sue the analyist.  Perhaps a few billion dollar "class action" lawsuits will slow the parasites down.

 

Analyist portray themselves to be so called experts in the business,  sounds like a good idea to me.

Doug (Out in the cold)
Oct 27, 2011 6:44PM
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Zhang Yesui, Chinese Ambassador to the United States, stated that Chinese investment in the US currently accounts for only a small portion in China's overall foreign direct investments and that China would like to increase investment in clean energy, environment and infrastructure.

 

Perhaps the G-20 meeting in Cannes, France will give President Hu Jintao and President Obama an opportunity to discuss the mutual benefits of Chinese investment into private sector industries and projects in America, to reduce the high unemployment in the United States, at a time when our public debt needs to be corrected.

MAD In USA
Oct 27, 2011 8:05PM
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Sounds like a lot of (I REALLY DON'T KNOW WHAT TO WRITE ABOUT TODAY) to me.Thinking
wildbilll5
Oct 27, 2011 9:55PM
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Your economic theories are surpassed.. only by your english composition skills Simon.  Bravo.
the leprechaun
Oct 27, 2011 7:58PM
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What coffee are you drinking?  You sound like a total plant with this information.  Yeah!
s53
Oct 27, 2011 9:39PM
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the stock market will not make any different to the economy when it was 10.500  or it will be 14.000 the only peoples that will benefit out of it is the stock brokers they fabricate numbers in the market. that the reason of all that demonstrations about europe they give injection to a sick body when the pain killer will gone they will retain to the same problems but this time all of them will end bankrupt
wildbilll5
Oct 27, 2011 9:28PM
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Last October Jubak predicted gloom and doom for the rest of the year...I listened and lost....
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