Cummins is an attractive dividend growth investment (NYSE: CMI )

Daniel Balakov

Introduction

As a dividend growth investor, I am constantly looking for new dividend growth opportunities. My diversified portfolio aims to provide a reliable stream of dividends and I am constantly looking for additions. Sometimes I add to existing positions that are attractive. others times I start new positions to diversify further.

With the stock market somewhat volatile in 2022, I believe there are opportunities to find additional investments. Cyclical sectors such as consumer discretionary and industrials may offer even more significant opportunities as investors seek refuge in safer, less volatile stocks. I will analyze Cummins (NYSE: CMI), a leading industrial company, in this article.

I will analyze the company using my methodology for analyzing dividend growth stocks. I use the same method to make it easier to compare researched companies. I’ll look at the company’s fundamentals, valuation, growth opportunities, and risks. Then I’ll try to determine if it’s a good investment.

Alpha Company Overview Search shows that Cummins designs, manufactures, distributes and services diesel and natural gas engines, electric and hybrid powertrains and related components worldwide. It operates in five segments: Engine, Transmission, Components, Power Systems and New Power. The company offers diesel and natural gas powered engines under the Cummins brands and other customers for heavy and medium duty trucks, buses, recreational vehicles, passenger cars, construction, mining, marine, rail, oil and gas, defense and agricultural markets.

Basics

The chart below shows how cyclical Cummins sales are. Demand for the engine increases when the economy is booming and decreases when it slows down. Over the past decade, sales have increased by 35%. The company has achieved growth mainly by expanding its production capacity. The company’s activity in the M&A arena is primarily to enhance its technological leadership. Going forward, the analyst consensus, as seen in Seeking Alpha, expects Cummins to continue to grow sales at an annualized rate of ~5% over the medium term.

Diagram
Data from YCharts

EPS (earnings per share) is growing faster. Over the past decade, EPS has grown by more than 40%. EPS is also cyclical as changes in demand affect the top and bottom lines. The company has maintained a stable operating margin over the decade. The increase in EPS was driven by a combination of increased sales and significant buyback activity. Going forward, the analyst consensus, as seen in Seeking Alpha, expects Cummins to continue to grow EPS at an annualized rate of ~11% over the medium term.

Diagram
Data from YCharts

The company is a consistent dividend producer. The company has not cut its dividend in over 25 years and has consistently increased it for over 15 years. The dividend is safe with a payout ratio of 42% as it leaves a sufficient margin of safety for future cyclicality. The current dividend yield of 2.9% is a comfortable entry point for long-term investors. Investors should expect another high single-digit dividend increase this month.

Diagram
Data from YCharts

In addition to dividends, which are the most important means of returning capital to shareholders, the company buys back its shares. Over the past decade, Cummins has bought back more than a quarter of its outstanding shares. When used by a growing company, buybacks complement earnings-per-share growth, and it makes sense for cyclical companies with a long track record to buy back shares when valuations are attractive, such as today. The company has a $2 billion buyback plan, which equates to 7% of the company.

Diagram
Data from YCharts

Valuation

The current P/E (price-to-earnings) ratio is 11.43 using projected earnings for 2022. As the chart below shows, this is the lowest valuation we’ve seen for Cummins in the past twelve months. Paying 11 times earnings for a company that is projected to show steady growth over the medium term makes a lot of sense to me.

Diagram
Data from YCharts

The chart below from Fastgraphs highlights how attractively the company is currently valued. Over the past two decades, the stock has traded at an average P/E of 15. Therefore, buying the stock at the current valuation is attractive. This is even more promising as the company is expected to continue growing over the next few years.

Fast graph analysis

Fast graphics

In conclusion, Cummins is a reliable company when it comes to fundamentals. It increases sales and EPS, which in turn drive dividend growth and buybacks. The company is trading at what I believe to be an attractive valuation with a P/E ratio at its lowest point in the past twelve months. This P/E ratio is also significantly lower than the average valuation.

Opportunities

North American supply chain challenges catalyze Cummins. The increased demand for logistics and the need to transfer goods increases the demand for trucks and rail engines. This macro trend is putting positive pressure on Cummins in the US to produce more units. Demand in North America is strong as companies must address supply chain bottlenecks.

Another macro trend fueling demand for Cummins products is rising raw material prices. This increases the need for engines in the mining sector. In addition, there is also a surge in demand for power generation equipment. Macro trends with higher energy prices are forcing countries to diversify and they need more electricity production.

Cummins also enjoys more capabilities that come with its size. The company is diversifying with several business segments that allow it to reduce cyclicality. In addition, it also enjoys geographic diversification as it sells its products in over 190 countries and territories. Diversification reduces risk and allows a company to take advantage of growth opportunities in different markets and products.

Risks

Weakness in China is a significant risk for Cummins. The company is selling in China as the country continues to increase its industrial capacity. In addition, China also needs more power to power its growing economy. Last quarter, Cummins suffered from lower demand due to the lockdown in China, which led to slower economic growth and depressed demand.

Inflation is another risk for Cummins as it increases the cost of labor and the cost of materials needed to produce engines. The company has maintained a 10% operating margin over the past decade. Significant inflationary pressures could put pressure on the company’s margins and hurt profitability. Higher prices can lead to lower market share and demand.

A recession is the third risk for Cummins. While this is a significant short-term risk, it is not an effective long-term risk. A recession will outpace demand and likely put pressure on EPS and share price. However, the company has weathered many recessions over the past few decades, and this volatility in this kind of company is no mistake. It’s a function.

Conclusions

Cummins is an excellent company with a long track record of solid performance. The company has enjoyed remarkable long-term growth despite the cyclical nature of its business. Therefore, investors can feel comfortable with its dividend growth and buyback. The company has several growth opportunities that will drive its development in the coming years.

There are, of course, risks to the investment thesis. In the short term, this is inflation and the risk of recession. Investors may also be concerned about slower growth in China’s economy. However, the current valuation leaves investors with quite a bit of security leeway. That’s why I believe investors can feel comfortable buying Cummins over the long term.

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