Buy Cummins India; target of Rs 1150: Motilal Oswal

Motilal Oswal's research report on Cummins India

Operating performance below estimates: Cummins India’s (KKC) 2QFY18 revenue declined 10% YoY to INR11.5b (our estimate: INR14.1b). Gross margin improved 170bp YoY to 36.9%. EBITDA declined 16% YoY to INR1.7b (our estimate: INR2.3b), with the margin contracting 110bp YoY to 14.5% (our estimate: 16.0%) due to negative operating leverage. PAT fell 22% YoY to INR1.5b (our estimate: INR1.9b).  Revenue declines across most segments. Domestic revenue declined 7% YoY, impacted by the power generation (-6% YoY) and distribution & spares (-14% YoY) segments. Exports declined 17% YoY due to weakness in LHP segment demand (-20% YoY). Gross margin expands led by cost savings and better product mix: Gross margin improved 170bp YoY to 36.9%, led by cost-saving measures (like value engineering initiatives with vendors) and a better product mix. KKC expects 2HFY18 gross margins to sustain at the current levels. Operating margin contracted 110bp YoY to 14.5%, given negative operating leverage.   Cutting guidance on exports, but maintaining on domestic revenue: For FY18, KKC lowered its exports growth guidance to -5-10% growth (from flat-to-negative 5%), and maintained its 5-10% growth outlook in the domestic business. It expects the domestic markets to bounce back over 2HFY18, recovering the lost sales of 2QFY18.

Outlook

We cut our earnings estimate by 12/6% for FY18/19E, given the weak outlook on the exports front. We maintain our Buy rating with a target price of INR1,150 (30x Dec-2019E EPS). The stock trades at 37x FY18E EPS of INR25.3 and 27x FY19E EPS of INR35. Key risks to our rating are (a) slower-than-expected growth in the domestic power generation market and (b) delay in pick-up of export demand.

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