Cummins India (KKC IN) Weak exports lead the operational miss

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1 INSTITUTIONAL EQUITY RESEARCH Cummins India (KKC IN) Weak exports lead the operational miss INDIA CAPITAL GOODS Quarterly Update Top takeaways from Q2FY16 Cummins earnings (Rs 1.9bn; 2% yoy) were in line with our estimates, as weak operational results (7% below our estimates) were offset by higher other income. Revenues and EBITDA were 6% and 7% below our estimates respectively as export revenues declined 9% yoy due to sharp decline in low horsepower (LHP) category against our estimate of 10% growth. However, the positive surprise was the continued growth in domestic sales (10% yoy) led by strong 27% yoy growth in its power gen business. Key highlights: Sales (Rs 11.9bn, +5% yoy) were below our estimate of Rs 12.8bn. Gross margins declined 70bps yoy, but were up 110bps qoq (in line with the management s guidance of a sequential recovery). EBITDA margins expanded marginally (20bps yoy to 16.8%, in line), but lower revenues meant EBITDA was 7% below our estimates at Rs 2bn. However, PAT at Rs 1.9bn ( 2% yoy) was largely in line with our and consensus estimates due to higher other income, which was buoyed by dividend from subsidiaries. Conference call takeaways Management indicated that its domestic business is benefitting from new capacity creation leading to higher demand in its power gen segment coupled with market share gain (after having lost share last year when it raised ASP s in its LHP category). However, despite pick up in domestic sales, capacity utilisation at its plants is still 60%. We see an upside risk to the management s revenue guidance for its domestic business (10 15% growth) while its guidance of 0 5% growth in exports will be a drag. Because of this, we have cut our revenue estimates for FY16/17 by 5%/3% respectively. Over the mid to long term, Cummins India should benefit from its parent Cummins Inc s plans to restructure its sourcing strategy towards low cost countries. Outlook and valuation We are enthused by Cummins above industry growth in the domestic market and more so by its power gen business, which is reflective of an on ground recovery in capacity creation. However, weak outlook on exports (which was expected to be a key growth driver over FY16 17), is a negative surprise. Even as we now bake in higher domestic sales growth, our assumption of lower export sales drives a 4% cut in our FY17 earnings. Consequently, we cut our target price to Rs 1,050 (from Rs 1,100 earlier). We maintain our Neutral rating as current valuations of 30x FY17 P/E price in a domestic sales recovery while lower thanexpected exports will be a near term drag on the stock price. 6 November 2015 Neutral (Maintain) CMP RS 1045 / TARGET RS 1050 (+0%) COMPANY DATA O/S SHARES (MN) : 277 MARKET CAP (RSBN) : 296 MARKET CAP (USDBN) : WK HI/LO (RS) : 1247 / 722 LIQUIDITY 3M (USDMN) : 4.8 PAR VALUE (RS) : 2 SHARE HOLDING PATTERN, % Jun 15 Mar 15 Dec 14 PROMOTERS : FII / NRI : FI / MF : NON PRO : PUBLIC & OTHERS : Key Financials Rs mn FY15 FY16E FY17E Net Sales 43,211 50,080 60,405 EBIDTA 6,504 8,546 10,948 Net Profit 6,107 7,854 9,719 EPS, Rs PER, x EV/EBIDTA, x ROE, % Debt/Equity (%) BLM Cons EPS, Rs CHANGE IN ESTIMATES Revised Est. % Revision Rs bn FY16E FY17E FY16E FY17E Revenue 50,080 60,405 5% 3% EBITDA 8,546 10,948 5% 8% Core PAT 7,854 9,719 0% 4% EPS (Rs) % 4% Jonas Bhutta & Hrishikesh Bhagat (Rs mn) Q2FY16 Q2FY15 yoy growth % Q1FY16 qoq growth % vs. expectations % Comments Sales 11,977 11,440 5% 13,143 9% 6% Sales below estimate due to weak export growth Gross margin 37.6% 38.3% 36.5% EBITDA 2,007 1,899 6% 2,180 8% 7% EBITDA missed estimate on higher employee cost EBITDA margin (%) 16.8% 16.6% 16.6% EBIT (%) 15% 15% 15% PBT 2,405 2,412 0% 2,575 7% 4% Recurring PAT 1,986 2,024 2% 2,107 6% 3% PAT largely in line due to higher other income Reported PAT 1,986 2,024 2% 2,107 6% 3% EPS % 7.6 6% 3% Page 1 PHILLIPCAPITAL INDIA RESEARCH

2 Quarterly results RS MN Q216 Q215 % CHANGE Net Sales 11,977 11, % Raw Material 7,470 7, % % of sales 62.4% 61.7% Employee cost 1,085 1, % % of sales 9.1% 8.9% Other Expenses 1,416 1, % % of sales 11.8% 12.8% EBITDA 2,007 1, % EBITDA margins (%) 16.8% 16.6% Depreciation % EBIT 1,808 1, % EBIT margins (%) 15.1% 14.8% Interest % Other Income % PBT % Tax % PAT 1,986 2, % PAT Margin (%) 16.6% 17.7% EPS, (Rs) % Source: Company, PhillipCapital India Research Estimates Balance sheet Y/E Mar, Rs mn Q2FY15 Q4FY15 Q2FY16 Capital Reserves and surplus 27,599 28,311 32,404 Networth 28,154 28,865 32,959 Secured Loans long +short term Unsecured Loans Total Loans Lease rent Payables Deferred Tax Liability Total LIABILITIES 28,801 29,496 33,645 Fixed Assets 13,037 14,046 17,371 Investments (current+non current) 1,768 4,650 1,614 Deferred tax assets Current Assets Inventories 6,700 6,823 7,217 Debtors 9,173 9,355 9,426 Cash and bank balances 2, ,061 Loans and Advances (short term+long term) 7,533 7,471 8,169 Other Current Assets Total Current Assets 26,342 24,521 26,015 Current liabilities (trade payables+other current) 10,209 8,520 9,292 Provisions (short + long term provisions) 2,139 5,202 2,063 Total Current Liabilities 12,348 13,721 11,355 Net current assets 13,994 10,800 14,660 TOTAL ASSETS 28,799 29,496 33,645 Y/E Mar, Rs mn Q2FY15 Q4FY15 Q2FY16 Net working capital 11,062 10,001 13,599 % of sales 27% 23% 29% Page 2 PHILLIPCAPITAL INDIA RESEARCH

3 Financials Income Statement Y/E Mar, Rs mn FY14 FY15 FY16e FY17e Net sales 38,991 43,211 50,080 60,405 Growth, % Total income 38,991 43,211 50,080 60,405 Raw material expenses 25,416 28,557 32,470 38,559 Employee expenses 3,396 3,936 4,182 4,796 Other Operating expenses 3,987 4,215 4,883 6,101 EBITDA (Core) 6,192 6,504 8,546 10,948 Growth, % (17.9) Margin, % Depreciation EBIT 5,664 5,706 7,713 10,012 Growth, % (19.9) Margin, % Interest paid Other Non Operating Income 1,478 1,735 1,910 1,886 Pre tax profit 7,101 7,397 9,578 11,853 Tax provided 2,115 1,289 1,724 2,133 Net Profit 4,986 6,107 7,854 9,719 Growth, % (10.9) Net Profit (adjusted) 4,986 6,107 7,854 9,719 Wtd avg shares (m) Balance Sheet Y/E Mar, Rs mn FY14 FY15 FY16e FY17e Cash & bank ,988 Debtors 7,820 9,355 10,634 12,826 Inventory 5,513 6,823 7,710 9,189 Loans & advances 8,405 7,471 7,585 7,778 Other current assets Total current assets 22,756 24,521 26,567 31,882 Investments 4,954 4,650 4,450 4,250 Gross fixed assets 15,120 18,830 21,830 23,830 Less: Depreciation 5,928 6,491 7,324 8,260 Add: Capital WIP 827 1,706 1,706 1,706 Net fixed assets 10,019 14,046 16,212 17,276 Total assets 37,728 43,217 47,229 53,408 Current liabilities 6,910 8,520 9,132 10,512 Provisions 4,701 5,202 5,566 6,609 Total current liabilities 11,611 13,721 14,698 17,121 Non current liabilities Total liabilities 12,076 14,352 15,329 17,752 Paid up capital Reserves & surplus 25,097 28,311 31,346 35,103 Shareholders equity 25,652 28,865 31,901 35,657 Total equity & liabilities 37,728 43,217 47,229 53,408 Source: Company, PhillipCapital India Research Estimates Cash Flow FY14 FY15 FY16e FY17e Pre tax profit 7,101 7,397 9,578 11,853 Depreciation Chg in working capital 2, ,313 1,458 Total tax paid 1,978 1,124 1,724 2,133 Cash flow from operating activities 3,601 7,349 7,374 9,197 Capital expenditure 4,404 4,824 3,000 2,000 Chg in investments 1, Cash flow from investing activities 3,081 4,521 2,800 1,800 Free cash flow 519 2,828 4,574 7,397 Equity raised/(repaid) Debt raised/(repaid) Dividend (incl. tax) 4,195 4,517 4,818 5,963 Other financing activities 993 1, Cash flow from financing activities 3,201 2,893 4,818 5,963 Net chg in cash 2, ,434 Valuation Ratios FY14 FY15 FY16e FY17e Per Share data EPS (INR) Growth, % (10.9) Book NAV/share (INR) FDEPS (INR) CEPS (INR) CFPS (INR) DPS (INR) Return ratios Return on assets (%) Return on equity (%) Return on capital employed (%) Turnover ratios Asset turnover (x) Sales/Total assets (x) Sales/Net FA (x) Working capital/sales (x) Working capital days Liquidity ratios Current ratio (x) Quick ratio (x) Interest cover (x) Dividend cover (x) Total debt/equity (%) Net debt/equity (%) (3.4) (2.8) (1.7) (5.6) Valuation PER (x) Price/Book (x) Yield (%) EV/Net sales (x) EV/EBITDA (x) EV/EBIT (x) Page 3 PHILLIPCAPITAL INDIA RESEARCH

4 Stock Price, Price Target and Rating History N (TP 1100) B (TP 1020) B (TP 885) N (TP 925) 700 B (TP 710) B (TP 765) 600 S (TP 415) S (TP 440) B (TP 520) 500 N (TP 415) 400 B (TP 520) S (TP 370) B (TP 340) 300 J 13 F 13 A 13 M 13 J 13 A 13 O 13 N 13 J 14 F 14 A 14 J 14 J 14 S 14 O 14 D 14 J 15 M 15 M 15 J 15 A 15 S 15 Rating Methodology We rate stock on absolute return basis. Our target price for the stocks has an investment horizon of one year. Rating Criteria Definition BUY >= +15% Target price is equal to or more than 15% of current market price NEUTRAL 15% > to < +15% Target price is less than +15% but more than 15% SELL <= 15% Target price is less than or equal to 15%. Page 4 PHILLIPCAPITAL INDIA RESEARCH

5 Management Vineet Bhatnagar (Managing Director) (91 22) Kinshuk Bharti Tiwari (Head Institutional Equity) (91 22) Jignesh Shah (Head Equity Derivatives) (91 22) Research Automobiles Engineering, Capital Goods Midcap Dhawal Doshi (9122) Jonas Bhutta (9122) Amol Rao (9122) Nitesh Sharma, CFA (9122) Hrishikesh Bhagat (9122) Portfolio Strategy Agri Inputs Infrastructure & IT Services Anindya Bhowmik (9122) Gauri Anand (9122) Vibhor Singhal (9122) Deepan Kapadia (9122) Technicals Banking, NBFCs Subodh Gupta, CMT (9122) Manish Agarwalla (9122) Logistics, Transportation & Midcap Pradeep Agrawal (9122) Vikram Suryavanshi (9122) Production Manager Paresh Jain (9122) Ganesh Deorukhkar (9122) Metals Consumer, Media, Telecom Dhawal Doshi (9122) Database Manager Naveen Kulkarni, CFA, FRM (9122) Yash Doshi (9122) Deepak Agarwal (9122) Jubil Jain (9122) Manoj Behera (9122) Oil & Gas Editor Sabri Hazarika (9122) Roshan Sony Cement Vaibhav Agarwal (9122) Pharma Sr. Manager Equities Support Surya Patra (9122) Rosie Ferns (9122) Economics Mehul Sheth (9122) Anjali Verma (9122) Sales & Distribution Corporate Communications Ashvin Patil (9122) Sales Trader Zarine Damania (9122) Shubhangi Agrawal (9122) Dilesh Doshi (9122) Kishor Binwal (9122) Suniil Pandit (9122) Sidharth Agrawal (9122) Execution Bhavin Shah (9122) Mayur Shah (9122) SINGAPORE Phillip Securities Pte Ltd 250 North Bridge Road, #06 00 RafflesCityTower, Singapore Tel : (65) Fax: (65) JAPAN Phillip Securities Japan, Ltd 4 2 Nihonbashi Kabutocho, Chuo ku Tokyo Tel: (81) Fax: (81) THAILAND Phillip Securities (Thailand) Public Co. Ltd. 15th Floor, VorawatBuilding, 849 Silom Road, Silom, Bangrak, Bangkok Thailand Tel (66) Fax: (66) UNITED STATES Phillip Futures Inc. 141 W Jackson Blvd Ste 3050 The Chicago Board of TradeBuilding Chicago, IL USA Tel (1) Fax: (1) Contact Information (Regional Member Companies) MALAYSIA Phillip Capital Management Sdn Bhd B 3 6 Block B Level 3, Megan Avenue II, No. 12, Jalan Yap Kwan Seng, Kuala Lumpur Tel (60) Fax (60) INDONESIA PT Phillip Securities Indonesia ANZTower Level 23B, Jl Jend Sudirman Kav 33A, Jakarta 10220, Indonesia Tel (62) Fax: (62) FRANCE King & Shaxson Capital Ltd. 3rd Floor, 35 Rue de la Bienfaisance Paris France Tel (33) Fax : (33) AUSTRALIA PhillipCapital Australia Level 37, 530 Collins Street Melbourne, Victoria 3000, Australia Tel: (61) Fax: (61) INDIA PhillipCapital (India) Private Limited No. 1, 18th Floor, Urmi Estate, 95 Ganpatrao Kadam Marg, Lower Parel West, Mumbai Tel: (9122) Fax: (9122) HONG KONG Phillip Securities (HK) Ltd 11/F United Centre 95 Queensway Hong Kong Tel (852) Fax: (852) CHINA Phillip Financial Advisory (Shanghai) Co. Ltd. No 550 Yan An East Road, OceanTower Unit 2318 Shanghai Tel (86) Fax: (86) UNITED KINGDOM King & Shaxson Ltd. 6th Floor, Candlewick House, 120 Cannon Street London, EC4N 6AS Tel (44) Fax: (44) SRI LANKA Asha Phillip Securities Limited Level 4, Millennium House, 46/58 Navam Mawatha, Colombo 2, Sri Lanka Tel: (94) Fax: (94) Page 5 PHILLIPCAPITAL INDIA RESEARCH

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