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Morningstar | Cummins Reports Record Earnings in 3Q; Higher Volumes Improve Margins. See Updated Analyst Note from 01 Nov 2018

Exceptional conditions in the third quarter for narrow-moat Cummins contributed to record earnings as robust demand for trucks, construction equipment, and power generation drove sales to increase 12% from the prior-year third quarter. North American sales were particularly strong as they grew 17%, while international grew a more modest 6%. Considering this ongoing performance, we maintain our $159 fair value estimate.

Sales in the quarter were mixed across geographic regions. Further indication of U.S. economic strength was a 36% increase in sales for construction equipment engines in the region. Power Systems sales in the U.S. witnessed elevated demand from oil and gas customers that was partially offset by sluggish marine and mining sales. Dragging down international sales was a 7% decline in revenue in China. Industry demand for engines for medium- and heavy-duty trucks in China was particularly weak as it declined 24%, in line with management expectations. Yet, growth for Cummins’ Power Systems business in China was a robust 8% due to increased demand from mining, data center, and oil and gas customers. A more positive note on the international front was Brazil, with revenue increasing 16% due to its recovering economy.

Cummins grew operating income 29% to $803 million, and operating margins expanded about 170 basis points to 13.5%. Management expects roughly $80 million in expenses related to trade tariffs in 2018, down from its previous estimate of $100 million. We will continue to monitor tariff-related expenses but believe underlying economic growth in multiple regions will outweigh the short-term headwinds.

Management reiterated its commitment to developing electrified power trains, especially for urban and shorter-range application. Customer interest in this technology is strong. EBITDA losses for the Electrified Power segment were $30 as Cummins invested in new products to serve this sector.

During the third quarter, management returned $682 million of cash to shareholders out of approximately $1 billion in operating cash flow. This is consistent with its stated plans of returning 75% of cash to shareholders this year. Going forward, the company plans to continue this trend as the board of directors recently approved a new $2 billion share repurchase program.