Engine maker Cummins (NYSE: CMI) was founded in 1919, making 2019 its 100-year anniversary. But as it reaches its centennial, it faces a challenge like it's never seen before. In fact, management is projecting that revenue growth will stall as it celebrates this incredible milestone. Is this just a speed bump, or is the changing shape of transportation going to cause Cummins to break down?
A hard act to follow
In 2018, Cummins saw revenue advance a hefty 16%, with earnings jumping nearly 24%. That was helped along by strong demand in the trucking market and tax law changes. Still, at the end of the day, last year was a very good one for this industrial company, which is why it was so disappointing to see what management was expecting in 2019.
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The company is projecting that 2019 revenue growth will be flat to up 4%. That would represent a material year-over-year deceleration. The driving force behind that decline is expected to be China, where some key markets appear to be softening. However, during the company's fourth-quarter 2018 conference call, CEO Tom Linebarger was cautious about his assessment of U.S. truck sales, Cummins' biggest market. He suggested that the highly cyclical truck industry could quickly deteriorate if 2018 proves to be a market top. That's true even considering the strong backlog of orders, since cancellations can lead to swift changes to the industry's outlook.
In fact, U.S. heavy truck orders have been weak for several months. Some industry watchers are even suggesting that the heavy-truck market's boom/bust cycle is quickly shifting toward the bust side of the equation. If this trend continues, revenue in Cummins' big anniversary year could go from flat to slightly higher, to down year over year. That wouldn't leave much to celebrate.
However, there are long-term issues to consider here, too. For example, Cummins is known for its diesel engines. While that technology isn't exactly going away overnight, more vehicle manufacturers are looking to electricity, even for heavy-duty trucks. Take, for example, vehicle industry maverick Tesla's big truck reveal in 2017. Since Tesla's habit of pushing industry boundaries spurred larger peers to action with electric cars, there's a good chance it is doing the same with trucks. This is likely to be a notable headwind over the long term and another concern that investors need to keep in mind as Cummins celebrates its 100-year anniversary.
Cummins has ridden the gasoline engine for a century at this point. With so much change in the vehicle market, it's not unreasonable to wonder if 2019 is going to be a key inflection point.
Watch, but don't worry too much
The answer is probably not. The heavy-duty truck market is highly cyclical. A downturn isn't the end of the world -- it's just par for the course. And with so much experience in the space, Cummins is used to these big swings. For example, long-term debt makes up less than 20% of the company's capital structure. That, by design, provides Cummins with the financial strength it needs to survive an industry downturn so it can reap the rewards of the inevitable upturn.
So, even if 2019 turns into a bust, don't fear for the future of Cummins; consider any stock sell-off a potential buying opportunity.
That's doubly true because of the company's investment in electric. The business, which is only about a year old, had negative EBITDA of $90 million in 2019. That included one-time costs, one of which was related to the shutdown of a business. That's not exactly an auspicious start. However, it gets worse: The company is projecting negative EBITDA of as much as $150 million in 2019. However, investors shouldn't fret too much. Cummins is investing for the future, here, and that inherently requires a little cash burn. It's not surprising that this new division is a drag today.
What's important is that Cummins isn't letting itself stagnate. It's pushing into the emerging niches that are likely to displace its core business over time. This suggests that, even if 2019 is a difficult year for Cummins, the long-term future remains on solid ground. To quantify the electric issue a little, the CEO noted during the fourth-quarter call that:
I've heard people project that the transit buses -- which I've mentioned is one of the best markets -- might be 50% electric in ten or more years. That's a long time, and that's for new buses, which means you've got all the diesel buses still selling ...
Basically, he was explaining that he doesn't think the world is at a major electric tipping point just yet. In fact, it's more likely to be a slow-moving transition. And that means there's plenty of time for Cummin's core engine business to thrive and for it to build out a profitable and well-positioned electric operation. Note, too, that it already has strong relationships with most of the largest truck makers, so it would be an ideal partner for the industry as it looks to electrify.
This is definitely not the end
Cummins is likely to have a less inspiring year in 2019 than it had in 2018, but that's just par for the course in the highly cyclical trucking industry. And while the long-term threat of electric substitution is very real, Cummins is working to be a part of the transition. Cummins, at 100 years old, isn't at risk of going extinct. That said, its current price-to-book value ratio is a little high relative to its trailing-five-year average.
Investors interested in Cummins should keep it on their watchlist and wait for the next trucking bust to hit in full force, at which point this stock is likely to be put on sale. If the current industry trends continue, that could be soon.
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