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Morningstar | Cummins Reports Record Revenue in 4Q but Is Downbeat on Near-Term China Outlook; Maintaining FVE. See Updated Analyst Note from 06 Feb 2019

We maintain our $159 fair value estimate after narrow-moat Cummins reported mixed results for fourth-quarter 2018. It delivered record revenue of $6.1 billion that was 12% higher than the same quarter last year, roughly in line with consensus. Yet, GAAP EPS of $3.63 missed consensus by $0.16. Much of the revenue growth was attributed to robust truck production. The earnings miss was due in part to one-time costs associated with closure of an electronic logging device startup. Management provided 2019 guidance that was largely in line with our expectations. It expects healthy growth of truck production in North America and Brazil along with robust sales of power systems globally. Yet, it was downbeat on prospects for China where it expects most of its end markets to decline in 2019.

Sales in the quarter were mixed across segments and geographies. Strong engine sales, which were up 18% year over year in the quarter, were due to robust truck production in North America and off-highway construction equipment globally. While the company expects further sales growth in North America and Brazil, it forecast lower demand for construction equipment in China with excavators expected to decrease 25% in 2019. Further complicating matters in China is uncertainty around the adoption of a new emissions standard, National Standard VI, which is more stringent than other international standards. Cummins anticipates that trucks sales will decline 10% in China in 2019 with weak demand for vehicles compliant with the new standard.

Cummins' power systems segment was also a standout in the quarter with revenue increasing 9% year over year. Consistent with our research, the company experienced strong growth in sales to data centers. Power systems sales was one bright spot for Cummins’ business in China, with revenue growing 29% for the full year. In 2019, Cummins expects its global power systems to be its highest growth segment, with revenue increasing 3% to 7%.

During the earnings call, management noted its ongoing investments in digital services and its electrified power business. Recently, Cummins began selling battery electric powertrains to one school bus vendor and expects other launches later this year. However, management seemed less enthusiastic about future penetration of electric powertrains in the larger heavy-duty vehicle industry. We feel the potential for disruption posed by electric powertrains could be significant for the industry and Cummins in particular. Hence, we would expect to hear more concrete plans for investments in the sector given electric truck manufacturers Tesla and Nikola continue to announce preorders for their vehicles.