Cummins India. CMP: INR430 TP: INR462 Neutral

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1 BSE SENSEX S&P CNX 16,070 4,870 Bloomberg KKC IN Equity Shares (m) Week Range (INR) 515/322 1,6,12 Rel. Perf. (%) -3/30/-4 M.Cap. (INR b) M.Cap. (USD b) May QFY12 Results Update Sector: Capital Goods Cummins India CMP: INR430 TP: INR462 Neutral 4QFY12 Operating performance in-line: EBIDTA margins up 110bp YoY: Revenues of INR10.4b down 1% YoY was marginally below our estimate of INR10.9b, up 4% YoY. EBITDA margins at 18.7%, up 110bp YoY was above our estimate of 17.7%, flat YoY driven by better product mix and favorable currency movement coupled with benefits flowing in from cost reduction measures. PAT at INR1.4b up 0.4% YoY was in-line with our estimate. Domestic sales impacted; exports growth in low teens: Domestic sales declined 11.4% YoY v/s ~5% de-growth in 2Q/3QFY12, while export sales improved 6.3% YoY. Domestic revenue growth in FY13 could be constrained while LHP engine exports from FY14 is expected to be the next driver; and in the interim period the growth is expected to be in low teens given the base effect. Expects to maintain margins despite several headwinds: Management is confident of maintaining margins at current levels despite several headwinds. We believe that the recent announcement of 3% price increase (wef June 2012) and currency movement (for exports) could likely support near-term margins. Currency gains on exports beyond a band are being shared with the parent company. Most new technology products through 100% subsidiary of Cummins Inc: KKC's management stated that increasingly most of the new technology products will be manufactured / exported through a 100% subsidiary of Cummins Inc, while KKC will retain the India marketing rights. This could possibly lead to lower margins and also restrict the export opportunity, in the long run, as Indian market gradually evolves towards such products. Capex guidance revised upwards: KKC revised its capex guidance to ~INR6.5b each in FY13/FY14 vs its earlier guidance of INR5.5b/4.0b in FY13/14. Of the INR22b capex planned during FY11-15, ~65% pertains to the Office campus and a large part of the same will be shared with Cummins Inc group companies. KKC will receive lease / rental on the same. We believe that this is not a comforting as it will dilute the returns on capital employed. Valuation & View: We had recently downgraded KKC to Neutral from Buy (May 8, 2012) due to emerging headwinds like muted demand, increased competitive intensity, peak commodity prices, etc. Maintain Neutral. Satyam Agarwal (AgarwalS@MotilalOswal.com); Deepak Narnolia (Deepak.Narnolia@MotilalOswal.com); Tel:

2 Domestic sales impacted; exports to remain resilient despite global headwinds During 4QFY13, domestic sales declined 11.4% YoY to INR6.8b, while export sales improved 6.3% YoY. The slowdown in domestic sales has accentuated with 3QFY12 de-growth at 11.4% vs ~5-5.3% de-growth in 2Q/3QFY12. Power generation sales (31% of revenues) in 4QFY12 have been largely driven by Tamilnadu, which witnessed demand spurt. Thus, for the first time, Power generation sales in South were equivalent to the combined sales in North and West. While the orderbook continues to be strong for 1QFY13, the management stated that macro volatility has increased. Importantly, the inventory in the sales chain is down 50% YoY, and thus any possible demand growth could lead to a magnified near-term effect. However, we believe that market growth is likely to remain muted in FY13, and the impact is likely to be more pronounced in the HHP segment (contributes ~60-65% of power generation sales for KKC). Industrial business (13% of revenues) continues to be impacted, with sales down 6% YoY in FY12. The environment continues to be challenging, and except construction most segments are witnessing sales decline. Distribution and Spares business (19% of revenues) continues to report steady growth, given the annuity nature of the business. Exports (29% of revenues) are up 6.3% YoY in 4QFY12 and 11% YoY in FY12. Growth will continue to be steady going forward, and will largely be a function of i) existing product portfolio of KKC (growth to be in low teens given the base effect) and ii) Low Horse Power plant to manufacture gensets being set up at Phaltan (to be commissioned by mid 2014, potential revenues of INR10b). New technology products will be manufactured for the export market through a 100% subsidiary of Cummins Inc, with the first engine being QSK60 (>2500hp, can be a INR2.5b pa opportunity, India market ~180 engines per annum). Domestic revenues continue to be negative Exports growth rates decline Source: Company/MOSL 17 May

3 Segmentwise growth: Most businesses impacted in FY12 Revenue mix (4QFY12) Source: Company/MOSL 4QFY12 margin improvement driven by product mix change; structural headwinds exist going forward EBIDTA margins in 4QFY12 stood at 18.7% (up 83bp QoQ) and were higher than our estimates of 17.7%. The management stated that a large part of the improvement is being driven by mix change towards HHP segment / increased power generation sales (high margins) and operating leverage. For FY13, the management guided that margins will be maintained. While there exists several headwinds, we believe that the recent announcement of 3% price increase (wef June 2012) and currency movement (for exports) could likely support margins. Currency gains on exports beyond ~3% band are being shared with the parent company, and thus the entire gains from INR depreciation is not being retained by KKC. Headwinds to margins include: i) Commodity prices at peak, with pig iron prices (~50% of raw materials) up 15% YoY and 7% QoQ ii) Increased competitive intensity particularly in HHP segment (dominated by KKC with market share of ~55-65% accross product range) and iii)mix change to LHP segment. Structurally, long term margins could be impacted as new technology product ranges will most likely be manufactured and exported by 100% subsidiary of Cummins Inc, with KKC retaining the domestic marketing rights. Impact of material cost savings declining (as % of PBT) Pig Iron prices up 15% YoY Source: Company/MOSL 17 May

4 New emission norms - a positive for KKC All diesel engines (upto 800kva) used for power generation have to comply with new emission norms, starting July The company expects to gain significant competitive advantage from this due to its superior product development capabilities. The average realization (and profitability) of such engines is likely to be significantly higher (approx 20-30% higher). The management stated that ~65% of KKC's power generation revenues comes from such engines. Increased capex, INR14b capex towards office campus / Technology Centre also for Cummins Inc group companies KKC expects a total capital expenditure of ~INR6.5b each in FY13/FY14; and is meaningfully higher than the targets stated in February 2012, at INR5.5b in FY13 / INR4.0b in FY14. Of the INR22b capex planned during FY11-15, nearly 65% pertains to the Office campus / India Technology Centre and a large part of the same will be shared with Cummins Inc group companies. KKC will receive lease / rental income on the same, and we believe that this is not a comforting signal as will dilute the returns on capital employed. Work at Cummins' Phaltan mega site is on in full swing. As of now, four new factories have already started production in the Megasite, including Tata Cummins' 6-litre engine plant (60,000 engines per year), Distribution rebuild centre (part of CIL) and Reconditioning plant (part of CTIL) and the company is ramping up another facility, Parts distribution centre which got commissioned recently. Impact of material cost savings declining (as % of PBT) Pig Iron prices up 15% YoY Source: Company/MOSL Valuation and view We had recently downgraded KKC to Neutral from Buy (May 8, 2012) on the back of emerging headwinds (like muted demand, increased competitive intensity, peak commodity prices leading to inflationary pressure on margins, etc). We model FY13/14 revenue growth of 11.2%/12.8% and EBITDA margin of 17.9%/ 18.1% (FY12: 16.9%). Our EPS estimate stands at INR 22.3 (up 11%) and INR25.7 (up 15%) for FY13 and FY14, respectively. We have marginally downgraded our earnings estimate by 1.7% for FY13 and 2.4% for FY14. Our target price stands at INR462 (earlier INR474) based on 18xFY14E EPS. On current estimates, KKC trades at 20xFY13E and 17.5x FY14E. Maintain Neutral. 17 May

5 Cummins India: an investment profile Company description Cummins India Limited (formerly known as Kirloskar Cummins Limited) is a 51 % subsidiary of Cummins Inc, USA, the world s largest independent diesel engine designer and manufacturer, with a range from 205 HP to 2,365 HP, and a value packages service provider. Key investment arguments With growing power shortage in the country, demand for DG sets is likely to grow at a strong pace in the next few years. Cummins India, with a market share of over 40%, stands to gain significantly from the opportunity. Cummins Inc has identified India as a key outsourcing destination for its global markets. Most of Cummins India s exports are for power generation applications. Key investment risks Rising commodity prices and increasing competitive intesity can hamper margins. Rising interest rates and macro headwinds are likely to have a negative impact on demand. Recent developments Four new factories started production at the Megasite, including Tata Cummins 6-litre engine plant (60,000 engines per year), Distribution Rebuild Comparative valuations Cummins Crompton Thermax P/E (x) FY13E FY14E P/BV (x) FY13E FY14E EV/Sales (x) FY13E FY14E EV/EBITDA (x) FY13E FY14E Center and Reconditioning Plant. Another facility, Parts Distribution Center was commissioned recently. The company is also setting up a 200 KVA DG set facility, largely for the export market, which will have eventual capacity of 40,000 units per year. This plant is likely to be commissioned in 2HFY13. The Cummins Group is investing USD m over the next five years, to significantly augment capacities in India, both for domestic and export markets. Of this, KKC invested nearly INR2.5b/3.1b in FY11/12 and is likely to spend around INR4-5b per year till FY15E. Valuation and view We had recently downgraded KKC to Neutral from Buy (May 8, 2012) in light of emerging headwinds like muted demand, increased competitive intensity, peak commodity prices, etc. We maintain Neutral, with a revised target price of INR462 (earlier 474) based on 18xFY14E EPS. Sector view We remain Neutral on the sector. EPS: MOSL forecast v/s consensus (INR) MOSL Consensus Variation Forecast Forecast (%) FY FY Target price and recommendation Current Target Upside Reco. Price (INR) Price (INR) (%) Neutral Stock performance (1 year) Shareholding pattern (%) Dec-11 Sep-11 Dec-10 Promoter Domestic Inst Foreign Others May

6 Financials and Valuation 17 May

7 N O T E S 17 May

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