Dividend Stock Analysis – CMI

I’ve noticed that several investors I follow are moving into the automotive industry. Regarded Solutions posted an article on Seeking Alpha stating that Ford (F) was “seriously undervalued”, and Special Agent Dividend added it to his portfolio in the past month. Now, for reasons I don’t want to get into, I will never buy stock in an American car company. But with so many people being interested in Ford, GM (GM), and other supposedly-undervalued automotive stocks, I figured I would take a look at the automotive supply chain instead to see if any interesting companies popped up.

One good company did, in Cummins Inc (NYSE:CMI).

Quick Background:

Quoting from Scottrade:

Cummins Inc. is a diesel engine manufacturer. The Company designs, manufactures, distributes and services diesel and natural gas engines, electric power generation systems and engine-related component products, including filtration, exhaust aftertreatment, fuel systems, fuel systems, controls systems, air handling systems and electric power. The Company sells its products to original equipment manufacturers (OEMs), distributors and other customers worldwide. It serves its customers through a network of more than 600 company owned and independent distributor locations and more than 6,500 dealer locations in more than 190 countries and territories.

The company was founded in 1919 by Clessie Cummins and William Irwin, and is based in Columbus, Indiana. It is number #168 on the Fortune 500. CMI has four business units: Engines, Power Generation, Distribution, and Components. Target customers are varied in the agricultural, mining, oil and gas, construction, and automitive markets. The company generates over half its revenues internationally, and has a solid foothold in the UK, China, India, and Brazil. The company’s main competitors include GE (GE), Caterpillar Inc (CAT), and Honeywell Inc (HON).

For more basic information, check out the company’s website and the 2013 annual report.

Fun fact: An investment of $10,000 in December 2000 would be worth $198,902.57 today, all dividends reinvested. This yields a annual rate of return of 24.1%. (Source: FAST Graphs)

Investment Criteria:

So now that we have a basic understanding of who CMI is and what it does, let’s run our basic screening criteria on it, with the help of David Fish’s US Dividend Champions List:

• Pays a dividend: Yes
• Has 5+ years of dividend increases: Yes (9 years)
• Has not frozen dividend for over 8 quarters: Yes
• Has a Chowder number of 12 or more: Yes (32.6)
• Has am EPS payout ratio of less than 70%: Yes (36.75%)
• Pays a dividend monthly or quarterly: Yes (Quarterly; February, May, August, November)

CMI passes all six criteria. Let’s use FAST Graphs for the next round of criteria:

• Has an S&P Quality Ranking of ‘A-‘ or better: Yes (A-)
• Has generally increasing earnings over the past 10 years: Yes
• Is fairly valued/undervalued according to the Normal P/E ratio (blue line): Yes
• Is fairly valued/undervalued according to the Intrinsic P/E ratio (orange line): Yes

Other Bonus Ratings:

• S&P Capital IQ: 5-star strong buy
  • Scale is 1-5, 1 being ‘strong sell’, 5 being ‘strong buy’
• Thompson Reuters StockReport: 6 (optimized score of 6)
  • Scale is 1-10, 10 being best, 1 being worst
  • Optimized scores weight insider trading and price momentum heavier than other criteria
• Value Line: 3 for safety; 2 for timeliness
  • Scale is 1-5, 1 being best, 5 being worst

Financial Overview:

CMI has a respectable dividend yield of 2.16%. The payout is $0.78 per quarter, $3.12 annually. Although the dividend was frozen at $0.30 per quarter for about a decade before mid-2006, it seems CMI has taken the dividend a lot more seriously since then. The 10 year dividend growth rate is 22.3%, and the one, three, and five year dividend growth rates are in the 25-37% range. Such a solid DGR bodes well for the future, and I see no real threat to that trend. The company’s debt/equity ratio of 0.22 is very good for an industrial company, and management actively tries to avoid taking on debt. Interest payments are trivial at $41 million per year, and the company has $2.699 billion in cash and cash equivalents on hand. Shockingly, the debt/equity ratio is a full 1/10th of the peer group’s average of 2.0, a very positive sign. The company also executed three 2-for-1 stock splits in 1993, 2007, and 2008.

The P/E ratio is fair at 16.44, and Morningstar has a one year forward P/E ratio of 13.4, suggesting solid growth in earnings. Compared to its peer group, CMI’s gross margin is a bit lower than the peer group’s average (25.56% vs 27.90%). CMI’s operating, and net profit margins are all better (12.48% vs 10.24%, and 9.24% vs 8.5%). (Source: Scottrade) Finally, Morningstar rates the economic moat as ‘narrow’ and leadership as ‘standard’.

For the next five years, it is projected that CMI’s earnings will grow 16.4%, and that the estimated total return will be 17.9%, which is a very solid return as-is. For comparison, GE’s five year ETR is 10.2%, CAT’s is 9.9%, and HON’s is 8.8%. This hints that CMI will solidly outperform its peer group in the next few years. (Source: FAST Graphs)

Risk Factors:

One risk I notice with CMI is that it relies heavily on a few key customers for a large part of its revenue. According to Morningstar, five companies (PACCAR, Volvo Trucks North America, Daimler, Chrysler, and Ford) make up 30% of revenue. Granted, many of these relationships are organized such that CMI is an exclusive diesel engine supplier to these companies (see PACCAR, Ford Brazil, and Chrysler’s Dodge Ram). But relying on a few key customers is never really a good thing. Compound that with the fact that while the industries CMI works in are very cyclical, engine manufacturing is consistently resource-intensive. That means that while fixed costs are always high, revenues can be high or low, and if the trough of the cycle lasts longer than expected, it could possibly hurt earnings, free cash flow, and the dividend. Finally, because CMI’s engines are usually placed in consumer and commercial vehicles, government regulations directly affect them. The EPA could create new regulations regarding emissions and environmental safety, while Congress could pass laws in the same area. If CMI is not careful, or management doesn’t adjust properly, new regulations could seriously hurt the company.

Some good SeekingAlpha articles on CMI can be found here (bullish), here (bullish), and here (bullish).

Final conclusion:

I believe CMI is an attractive investment, according to my criteria. It passes every single one. However, the price has popped a bit on the back of the most recent earnings announcement, so it runs the risk of becoming very slightly overvalued in the near term. I’m even more concerned about the cyclical nature of the industry, but CMI is far from the only company that has to deal with that. Also concerning is the over-reliance on a few key customers. If one fails or switches suppliers, that could cause a major dent in revenues. Conversely, I can’t find any data that indicates that a single customer provides more than about 5-6% of total revenues, so maybe it’s not a big an issue as it sounds. It is worth keeping an eye on though. On the positive side, I do love the dividend growth and the fact that earnings are increasing at a wonderful rate. Really, I don’t see a lot that truly scares me about the company, and there’s a lot to like. Ergo, I suggest investors go long CMI.

What do you think? Does CMI make the cut for your portfolio? Also, how can I improve future analyses?

Disclosure: I will most likely be going long CMI in the next week.

All data is accurate as of market close, 10/31/2014. My stock analysis archive page has been updated accordingly. Please read my disclaimer here before choosing to invest. Company logo image source is available here. Data source is FAST Graphs or company materials, unless otherwise indicated.

Tags: cmi, Cummins Inc, dividend-stock-analysis