Chris Bloomstran of Semper Augustus Investments Group presented his thesis on Cummins (US: CMI) at Best Ideas 2019.
Thesis summary:
Cummins, founded in 1919, designs, makes, distributes and services diesel and natural gas engines and components for truck makers such as PACCAR, Navistar, Daimler Trucks North America, Volvo and Fiat Chrysler. Chris first bought shares in 2018 at an average $142, about 10x earnings, for a 2% position. At year-end the stock sat near $134, down about 30% from its January 2018 high of $193, on fears of a truck slowdown and electric disruption.
Engines brought about 35% of revenue and distribution another third; components were a quarter of sales but over a third of operating profit. Reacquired distributors, within 7,500 dealer locations in 190+ countries, earn 20%+ returns on capital on cash flow margins near 7%. OEMs that build their own engines still want a parallel supplier: Caterpillar quit trucks under the 2000-2010 NOx rules, and Navistar, after an engineering disaster, handed about 70% of its engine capacity back to Cummins.
Chris argued the business was far less cyclical than perceived. It had not lost money since 1990, and the stock tended to fall before downturns and rise during them, gaining 75% in 2009 as sales fell about 25%. International was 54% of 2017 sales, and China light-duty share rose from 1% in 2012 to 8%. He saw battery Class 8 trucks as at least 15 years away, given $250,000+ prices, over 10% lost payload and no charging infrastructure.
ROE was about 31% and net ROC about 27% in 2018, falling only to the high teens at a cycle low, with net debt/EBITDA of 0.6x and a pension overfunded by $1.5 billion. Under Chairman and CEO Tom Linebarger and a long-tenured team, Cummins paid out a third of profits, a 3.4% yield, bought back 22% of its shares since 2006, and planned to return about three quarters of profits. Pay rewards ROE and return on average net assets, not sales growth.
At $134, Cummins traded at 9.6x expected 2018 EPS of about $14, a 10.4% earnings yield, on over $23 billion of revenue and over $2 billion of profit. Chris believed a business earning about 20% on capital through the cycle deserved 20x mid-cycle earnings: 20x normalized net income of $1.8 billion implied $220 a share, 65% upside. At 15x, allowing for disruption, the stock was worth $165, 24% upside. Risks included a Class 8 downturn, emissions rules, warranty charges, China tariffs and electrification.
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