Cummins Inc.

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 4/5

Cummins Inc. is a global power leader that designs, manufactures, distributes, and services a broad range of diesel, natural gas, electric, and hybrid powertrains and related components, including filtration, aftertreatment, turbochargers, fuel systems, controls, air handling systems, automated transmissions, electric power generation systems, batteries, and fuel cell systems.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Cummins operates in a cyclical industry and is exposed to risks regarding future customer demand, specifically related to the global economy, and has been impacted in the past from volatile commodity prices and increasing interest rates.

Business Explanation:

Cummins operates in four main segments: Engine, Distribution, Components, and Power Systems. Each segment contributes to the company’s revenue and is involved in the design, manufacture, distribution, and servicing of its products.

  1. Engine Segment: This segment develops and manufactures diesel and natural gas engines. The primary driver here is demand from medium and heavy-duty truck OEMs, and construction, agricultural, and mining companies. This segment is reliant on engine standards and fuel prices as well as broader economic trends.

  2. Distribution Segment: This unit distributes engines, generators and related equipment. Its main revenue is from spare parts and services as well as from sales of power solutions.

  3. Components Segment: This division manufactures and supplies emission aftertreatment products, filtration solutions, and turbochargers, and is subject to vehicle production rates, especially in commercial trucks. A significant portion of this segment’s revenue depends upon new technology introduction by CMI and by its competitors, as well as from their main clients.

  4. Power Systems Segment: This segment develops and manufactures power systems, mostly for industrial, oil and gas, data centers, healthcare, and marine applications, as well as providing other electric solutions. Revenue is driven by project-based sales and service agreements, therefore this division can fluctuate widely.

CMI is actively focusing on developing low and zero carbon technologies, which may help it compete in the future, even as the world’s energy sources shift away from fossil fuels, a primary part of its current business model.

Moat Analysis: 2/5

Cummins’ economic moat is narrow. A moat signifies a company’s long-term competitive advantage that protects it from competition. Here’s an analysis of why Cummins’ moat is limited:

  1. Brand Recognition: Cummins enjoys a solid reputation and customer loyalty, but brands alone aren’t enough to create an economic moat. While a well-known brand can facilitate sales and increase customer retention, it does not necessarily prevent competitors from introducing comparable products, as seen by its lack of moat from having consistent higher returns on invested capital than its peers.

  2. Patents & Technology: Innovation is crucial for growth in CMI’s industry, and despite investing heavily into R&D, their patents can still be challenged or bypassed by competitors, especially as technologies around cleaner fuels and electrification emerge. While having many patents can provide an advantage, there is not a clear path for their profits to keep growing significantly because of it.

  3. Scale Advantages: While CMI does have a global distribution network, allowing it to leverage economies of scale, this network doesn’t necessarily translate into higher profits as much as it does increased revenues. So, although CMI benefits from scale, their competitors in its industry also can have great efficiency, especially considering that there may be more profitable niches to be had with smaller companies.

  4. Switching Costs: Some of Cummins’ customers, notably in the power systems business, may experience high switching costs. However, in areas with commodity products that are easier to produce and distribute and that have more competition, the switching costs will not be high, and as such, do not give CMI much of a moat.

  • Rating Justification:
    • Given the above, there are aspects of CMI’s business that provide some competitive advantages, it is not enough for it to consistently generate outsized profits, making it a narrow moat company.
    • Overall, Cummins struggles to achieve superior returns, due to fierce competition in many of its operating segments. Although its business can at times have a decent position and performance in its sectors, it is not a consistently wide and entrenched moat.

Legitimate Risks and Business Resilience:

Cummins faces several risks that could harm its moat and business resilience:

  1. Cyclicality of Demand: As a manufacturer of large industrial and transportation equipment, the company’s revenues are closely tied to global macroeconomic cycles, and can be affected during downturns.
  2. Commodity Price Volatility: Fluctuations in raw material prices, especially for steel and other commodities, can significantly affect Cummins’ profit margins and make profitability much harder to accurately predict.
  3. Technological Disruption: While Cummins is investing in new technologies, if it falls behind its competitors in the electrification space, it could experience lower future sales, especially for internal combustion engines in commercial vehicles. In addition, newer technology could make some aspects of its business obsolete.
  4. Regulatory Changes: Stricter environmental regulations, including emission standards, could add costs and threaten CMI if it can’t make its products compliant. Also, changing regulations or restrictions around global trade can also limit its international sales.
  5. Competition: There is a lot of competition within CMI’s sectors, and its main clients are competitors as well.
  • Business Resilience:
    • Despite the risks, Cummins has shown resilience because of its diversification across its four segments.
    • It also has a focus on reducing costs, which will help it manage and thrive during volatile periods.
    • It is important that its revenue is not very dependent on any particular region and this has been historically its competitive advantage.

In-Depth Financials

Cummins financial position shows a business in transition, facing current difficulties while looking to the future. A brief summary of key financials:

  • Revenue: CMI has seen modest revenue growth, especially due to lower demand from some of its biggest clients. This shows the cyclical nature of its business, with sales moving in tandem with the economic cycle.
  • Profitability: While CMI has decent profit margins, these have varied over the last decade, and are highly dependent upon outside factors like raw materials costs, technology innovations, and regulatory changes. The recent history has shown lower margins for its Power Systems business, and the effects of acquiring its component parts for higher prices.
  • Cash Flows: The company has strong operating cash flows, allowing it to invest back into its business. However, this also means that CMI is at the whim of capital expenses related to new technological upgrades.
  • Balance Sheet:
    • Total Debt - The company holds a great amount of debt in its balance sheet - but also high amount of cash, so in reality it is better positioned than other peers to meet its obligations.
    • Working Capital - The company has a strong liquidity position with a current ratio over 1, but that figure has been declining over the last 4 years. CMI has been facing difficulty with receivables, and this should be considered when looking at the health of its balance sheet.
  • Shareholders Equity - Shareholders equity is around 11 billion, and has been growing steadily over the last 3 years. This shows investors that the company is solid enough to withstand large dips in the market as well as for unexpected issues to be resolved.

Cummins recently missed earnings, which resulted in its share prices going down. This was caused by various reasons that include higher costs, and lower demand. Its business, overall, is still in a strong position, but it is struggling in specific segments.

Understandability: 3/5

  • Cummins’ business model is relatively straightforward to grasp at a high level, but understanding the intricacies and cyclical influences within the industry requires more knowledge. * The various segments and types of offerings can be complex to understand, and requires familiarity with heavy machinery and similar industries. While understanding the main factors of CMI is easily attainable, understanding the underlying workings is much more difficult for average investors.

Balance Sheet Health: 4/5

  • Cummins has a decent capital position with some debt, but not so much that it will threaten its business. It also has lots of cash on hand and has an impressive equity value, which provides a very high margin of safety.

  • As long as management can navigate the company well, the health of its balance sheet should stay at a desirable level in the near and foreseeable future.

  • Disclaimer: This analysis is based on the provided information. It does not constitute investment advice, and is for general informational purposes only.