Streetwise

Lauren Rudd

Sunday, May 13, 2012

Do Not Make Investing Complicated

Why do so many of you want to make this investing thing so difficult? Simply look for investment candidates whose products you know and understand. You want companies that have both with a track record of positive earnings growth, dividends and a future that is aligned with the economy.

So now you are probably thinking that I should provide you with an idea to get you started. Ok, one possibility you might consider is Cummins (CMI).

Cummins came to my attention as a result of the recent Berkshire Hathaway annual shareholders meeting. At that meeting, Warren Buffett, Berkshire’s CEO, indicated that he is still interested in doing large deals, perhaps larger than Berkshire’s $34 billion Burlington Northern Santa Fe acquisition.

No sooner had he said that than the Street was rife with rumors as to what companies would meet Buffett’s stringent requirements. One of those mentioned repeatedly was Cummins.

It should be noted that another company mentioned regularly as one that could possibly be of interest to Buffett is Deere, a company discussed here several weeks ago. In fact, it is rumored that a possible deal was proposed by Berkshire but could not be consummated.

So why would Cummins interest Buffett? Cummins is a well- known brand with a foothold in some of the fastest-growing overseas markets and an easy-to-understand business. It manufactures portable generators and diesel engines. About 20 percent of Cummins’ sales come from China, Brazil and India, three of the fastest growing economies.

Expected to post record sales and earnings this year Cummins trades at a price that is about 10.3 times earnings (P/E) or a discount of more than 40 percent when compared to the average U.S. firm, according to Bloomberg.

Cummins’ operating cash flow this year will likely be more than triple on a per- share basis from what it was five years ago, while earnings have tripled over the past decade as a result of investments in growth, new products and leading-edge technology.

The Company’s sales were up 36 percent from 2010 to more than $18 billion, while earnings before interest and taxes (EBIT) were up 54 percent at $2.56 billion.

Net income in 2011 was $9.55 per share, up from $5.28 per share in 2010. If you exclude one-time charges and gains, net income was $9.07 per share with a tax rate of 26.3 percent.

First quarter saw revenues of $4.5 billion, an increase of 16 percent over the same period in 2011, driven by higher demand in truck, power generation and construction markets in North America and strong growth in global mining markets.

Growth in those markets offset weaker demand in the truck market in Brazil, the construction market in China and construction and power generation markets in Europe. Net income in the first quarter was $455 million or $2.38 per share as compared to $1.75 per share a year ago.

Cummins’ outstanding 2011 performance and its strong start to 2012 positions the Company to achieve its goal of $30 billion in sales by 2015. In addition, one of the most distinguishing features of Cummins is its gross margin improvement.

After remaining within a range of 25 to 26 percent in the past few quarters, the company achieved a 26.8 gross margin during the first quarter of 2012. An important factor behind this achievement was the Company’s declining warranty costs.

Cummins is also gaining from its leadership in the heavy natural-gas engines market, in part because of its partnership with Westport Innovations. Cummins Westport engines are fast emerging as the favorite among trucking companies.

The intrinsic value of the shares, using a discounted earnings model with a 12 percent earnings growth rate and a 15 percent discount rate is $210 per share. The more conservative free cash flow to the firm model offers up an intrinsic value of $165 per share, also utilizing a 12 percent growth rate.