Demand growth stays buoyant for Cummins India; profitability under pressure

Cummins India’s stock has gained 27 per cent since its lows in June, helped by a strong first quarter, expectation of improved demand and margin recovery. Some brokerages have revised their earnings estimates upwards but others are cautious.

Demand would be a key trigger for the company engaged in manufacturing, trading, selling engines, and allied activities. Cummins has said domestic and export demand remains strong. In the domestic market, select pockets in the industrial business have seen an uptick as segments in the diesel genset market drive growth. Key segments which are driving demand are pharma, biotech, realty, railways, telecom, mining and data centres.

Revenue in Q1FY23 was up 42 per cent and 13 per cent sequentially to Rs 1,687 crore. Sales in the domestic market, which accounts for 71 per cent of revenues, grew 36 per cent y-o-y. The exports market grew faster with sales rising 57 per cent over the year ago quarter.

While Europe (comprising a fifth of export revenues), Asia Pacific and Latin America witnessed a sales recovery, oil-dependent markets in Middle East and Africa saw higher demand and improved execution. Low horsepower (LHP) gensets grew 47 per cent y-o-y in Q1, compared to the high horsepower gensets that grew 35 per cent y-o-y.

What could aid incremental revenue growth are stringent pollution norms India is implementing from July 2023. This could lead to pre-buying in the December and March quarters of FY23. HDFC Securities believes that the company has multiple tailwinds, namely, stringent upcoming norms, capex cycle recovery, adoption of alternative fuels with lesser carbon footprint, revival in industrials and supporting manufacturing policies.

The company is confident of double-digit growth, but it refrained from giving any FY23 guidance given the geopolitical scenario, inflation, and supply chain concerns.

Sale in Q1 and outlook were strong, but margins were under pressure. Gross margins were down 330 basis points y-o-y and 90 basis points sequentially given the spike in commodity prices and inadequate (and delayed impact) of price hikes. While the company has taken multiple price hikes with the last one being in July, the higher raw material cost in the first half of the quarter dented gross margins. The company expects margins to recover given price hikes and easing commodity prices, but some brokerages believe profitability will be under pressure.

“Despite higher share of exports and distribution (higher margin) in the sales mix, gross margin was below the 30 per cent level. This highlights domestic pricing headwinds in LHP and construction. We expect such margin headwinds to re-emerge in the second half of FY24 after India Genset IV norms are implemented, which impacts LHP and mid-range powergen segments,” said Priyankar Biswas and Neelotpal Sahu, of Nomura Research.

The analysts expected a cost impact due to 20-30 per cent inflation after implementation of new norms; FY24 remains an election year which may impact ordering and construction, they add.

Elara Capital, however, is positive on the stock and has raised its FY24 earnings estimates by 8 per cent on the back of higher exports growth. The brokerage expects FY22-25 earnings to grow at 22 per cent annually while return ratios (on equity and capital employed) are expected to be 20 per cent. At the current price the stock is trading at 27 times its FY24 earnings estimates. Given the recent rally and macroeconomic uncertainty, investors should await clarity before considering the stock.