Buy, Sell, or Hold: Cummins Inc.

Q: As a newcomer to the stock market, I hear a lot about such companies as Caterpillar Inc. (CAT), Deere & Co. (DE), Komatsu Ltd. (OTC ADR: KMTUY), and others. Yet not much is said about Cummins Inc. (CMI). Do you have any insight, as I own about 2,000 shares?

So begins a letter from one of our more-dedicated readers.

In today's markets, it is extremely difficult to find winners.  With a market beset by soaring oil and energy prices, the forced liquidation of securities by large financial institutions that are quickly urged to comply with the U.S. Federal Reserve's capitalization requirements and the rest of the market afraid of its own shadow, rumors proliferate and bear raids abound.

Stocks that already represent a fine value get hit nonetheless and become even deeper bargains. Yet, it is precisely in these circumstances, as the Chicago Board Options Exchange Volatility Index - usually referred to as the VIX Index - is regarded as a proxy for fear in the markets. The index is once again quickly approaching the July 2007, January and March 2008 spikes above 32 that marked the broader market's tradable bottoms. We have to remain vigilant and look to scoop up bargains if this market ends up as a fire sale.

Enter Cummins Inc. (NYSE: CMI).  This no-nonsense Midwest industrial company is almost 100 years old, has been trading publicly since 1947, and is best known as the maker of bulletproof diesel engines.

But the Columbus, Ind.-based company is actually much more. Indeed, in many ways it's actually the ideal Money Morning/Money Map Report stock pick: It serves basic industries, is diversified globally and just boosted its dividend payout 40%.
Cummins does business in four areas:

  • Diesel and natural-gas-powered engines (52% of the company's overall revenue).
  • Electric-power-generation systems distribution systems (19% of revenue).
  • Power-generation systems (19% of revenue).
  • Engine components (10% of revenue).

The company holds leadership positions in all of its product areas. All these lines are in the “sweet spot” of increasing growth rates and margins due to the specific reasons that differentiate them from the rest of the market.

Very importantly, Cummins enjoys strong, sustainable competitive advantages in every segment of its business.  It has well-integrated product plans, focused on being the low-cost producer and developing strong distribution-and-servicing channels in all its markets across the globe.

That translates into consistent market-share dominance for most of its products. What's more, even though a great proportion (about 45%) of Cummins' sales come from the U.S. market, the huge spike in oil and gasoline prices has accelerated the U.S. migration into diesel engines, which are more- fuel efficient and have longer lives - and which is the company's dominant product line.

Diesel engines already are in widespread use overseas, where Cummins derives the remaining 55% of its overall corporate revenue. The company is particularly strong in Europe (18% of sales), Asia/Australia (20%) and Mexico/Latin America (9%).Cummins can expect a big long-term growth boost from its power-generation business, where the company has a big advantage in such product areas as standby, mobile and distributed power generation. This business is growing quickly overseas, because of the inadequacies of the national electricity-distribution grids and the risks to interruption in many emerging economies. 

With global growth across the world established solidly for the next two decades, and especially driven by the vast demands in China and India in power generation due to urbanization and industrialization, this business will be major growth driver for Cummins for years to come.

The company is very strong financially. Cummins has a market value of $13.4 billion. Last year it reported profits of $739 million on sales of $13.1 billion. Free cash flow was $1.23 billion. For all of 2008, Cummins is projecting that sales will advance 5% to $13.71 billion, while cash flow will increase 6% to $1.3 billion.

The input cost increase due to higher electricity and steel prices should pose no problem to Cummins' margins, since its market dominance, cost leadership, and the scarcity of these products across the board gives this industrial heavyweight plenty of pricing power. 

At Friday's closing price of $65.95, Cummins' shares were down 12% from their 52-week high of $75.09. But they're 73% above their 12-month low of $38.11. However, there has been some recent weakness, induced by forced liquidations and unrelated factors to Cummins' fundamentals. Ignore that as a negative: It actually only provides investors with an attractive buying opportunity. This opportunity is available to the very few, since the stock is under-covered by Wall Street, since it is boringly and consistently profitable.

Action to Take: BUY Cummins Inc. (CMI). Investors should rev up their purchases of this major maker of diesel engines and power-management systems.

[Editor's Note: Horacio Marquez was working as a vice president of the Merrill Lynch Emerging Markets Fixed Income Group in 1994 when he correctly predicted that both Argentina and Mexico were headed for currency crises - cementing his reputation as an expert on both the emerging markets and on the nuances of global finance. Now Marquez brings that expertise to you with the newly created "Shadow Stock Trader" specialized trading service. To find out how to subscribe, please click here. "Buy, Sell or Hold" is a brand-new Money Morning feature that so far has covered Cisco Systems Inc. (CS), and ABB Ltd., ADR: ABB). Readers should feel free to write to us and suggest a stock they'd like to see analyzed.]

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