Wednesday, October 10, 2012

Stock Bought: CMI

For my second purchase today I bought shares of Cummins (CMI), a world leader in the design and manufacture of diesel and natural gas engines. The company is at the forefront of developing better engine technology that meets stricter emission standards and is poised to take advantage of the increasing use of natural gas as a fuel source for vehicles.

I recently posted a quantitative comparison of CMI with one of its competitors in the heavy machinery industry, arguing that it is undervalued despite having solid fundamentals. Here is a recap:
  • Its 5-year historic growth rates for revenue and earnings are 9.70% and 21.87%, respectively, with low double-digit earnings growth expected over the next few years.
  • The company has a great balance sheet, with debt/capital of 9.60%, debt/equity of 12.34%, a current ratio over 2, and ample interest coverage.
  • The company has increased its dividend for 7 consecutive years, with an impressive 5-year dividend growth rate of 32.10% and a payout ratio of just 20%. This year's dividend increase was 25%.
  • CMI has a P/E of 8.74 (its 5-year average P/E is 15.10), P/S of 0.91, and PEG of 0.76. Using a Dividend Discount Model with a below-average dividend growth rate of 10% and a discount rate of 12%, I calculate a fair value of $110 per share, which implies a 20% margin of safety at the current stock price.
The stock price of CMI is near its 52-week low (and more than 30% off its 52-week high), dipping by more than 3% today after the company lowered its full-year revenue guidance and announced plans for 1,000 to 1,500 layoffs. The company attributes its actions to a slowdown in the global economy that has led to customers delaying capital expenditures. While this is not good news, I think it reflects short-term problems possibly linked to uncertainty regarding the fiscal cliff. In my opinion, Cummins has strong prospects for long-term growth.

I bought 15 shares of CMI at the price of $88.00 per share, giving me a 2.26% yield on cost. At the current dividend rate, I can expect to receive quarterly dividends of $7.50, which will add a total of $30.00 to my annual dividend income. Cummins is now the 25th stock in my portfolio. I had been waiting for an opportunity to initiate a position in CMI below $90, so I was glad to get it today. The company reports its quarterly earnings on October 30, which could lead to more price action at the end of the month. If the stock is still trading around the current level in early November (when I will have new capital), then I would consider increasing my position.

16 comments:

  1. DGM,

    Wow, I didn't know CMI had such a large pattern of dividend growth. That rate is strong!

    I'll have to take a look at CMI. I'm not sure how far off we are from natural gas engines in passenger cars being common place, as Big Oil still has a pretty firm grasp in that department, but any positive change here could benefit CMI big time. I like to hedge my bets, and holding CMI for favorable growth in this department could work well.

    The balance sheet is also surprisingly impressive for a big industrial company. Unusual, but wonderful.

    Best wishes!

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    1. Dividend Mantra: I hadn't really noticed CMI until a month or two ago, when I was running stock screens looking for undervalued dividend growth stocks with low debt. Its strong dividend growth and solid balance sheet jumped out as very attractive features.

      Cummins makes natural gas engines for large trucks and heavy duty machines, where there seems to be a stronger movement toward natural gas because of those vehicles' high fuel demands. However, if natural gas engines become more prominent in passenger cars, then the company could be well-positioned to make inroads in that area. I forgot to mention in my post that they also have several international joint ventures in emerging markets such as India and China that are likely to drive future growth.

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  2. Another great buy! I passed up on CMI because they don't provide annual reports, only 10-k forms. I like reading annual reports since I typically check my portfolio once per year so it's good to have management update the company through some sort of letter to shareholders. But that's just me. Have you looked at CAT or DE? I really like CAT and DE seems to have a really bright future.

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    1. Opps, CMI does have an annual report. Maybe I'll take a look at CMI again. Thanks for the heads up!

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    2. Henry: Somewhat different from other companies, they have a Chairman's letter that is separate from the 10-K form. I found both documents to be useful in my due diligence.

      I have indeed looked at CAT and DE. Both are undervalued and show good dividend growth, so they are similar to CMI in those respects. However, the balance sheets of CAT and DE are somewhat weak, especially for companies in a cyclical industry. Lately I have been seeking companies with strong balance sheets, so I was drawn to CMI over those alternatives.

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    3. Both CAT and DE have a financial component within the company. They use that to provide loans to buyers since their machines cost so much. So if you back out the financial component then the debt for both companies is fairly low.

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    4. Interesting, I didn't know that -- thanks! Perhaps I will dig a little deeper to get a better picture of their financial positions.

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    5. No problem! Just returning the favor for the tip on CMI. =)

      If you do a quick search for "debt" within each company's annual report then you should be able to see their debt. CAT and DE's debt (without financial products) are $9.1b and $3.7b, respectively.

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  3. We almost made 2 identical purchases today. I was very close to pulling the trigger on CMI this afternoon. There's starting to be more value and several stocks are getting close to where I feel comfortable investing. Sadly there's not enough capital to make all the purchases I'd like to. If it continues to pullback tomorrow you can expect another recent buy post from me. Great buy!

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    1. Passive Income Pursuit: I know how you feel about opportunities coming up and not having enough cash on hand. However, I'm pretty satisfied with the two purchases I made today. I have my last bit of cash earmarked for a slightly smaller purchase, which I might make soon. Then I'll just have to wait for new capital and hope there are still opportunities for it.

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  4. I like the reasons you're buying this, it isn't the yield. I think what you have here is a chance for massive gains and will be paid with rising dividends to wait. Sounds like a good plan!

    This thing has a super high beta, but the price is already depressed. Excuse my igonorance (I'm not familiar with Cummins), but why is it close to the 52 week low while the market has been on a tear?

    Looks good D

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    1. Compounding Income: You're right -- I consider this to be a strong long-term total return investment, combining solid dividend growth with the potential for large capital gains. I think it nicely fits with my value-oriented dividend growth investing approach.

      The stock is near its 52-week low because the company lowered its full-year guidance a few months ago (and did so for the second time earlier this week), so revenues are likely to be flat or slightly down for the year. This does not seem to be a company-specific problem: Caterpillar also lowered its guidance and a few companies in other industries have done the same.

      However, I view this as a short-term hiccup rather than a long-term problem and I think Cummins can weather a modest downturn (especially with its strong balance sheet). Consider this: Its revenue and earnings were hit hard in 2009 (as was the case for most companies), but it bounced back in the span of a year to operating results that were higher than before the recession. Their current lower guidance isn't anywhere near the 2009 level, yet the market is pricing the stock at the low end of its P/E range over the past 4 years. Thus, I think the market is overly pessimistic and CMI represents a good value investment. I guess we'll see in a few years whether I'm right!

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  5. Thank you for your update on CMI.
    I just sold some 85 put... couldn't resist at these price.

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    1. grox: You're welcome -- thanks for stopping by!

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  6. Great buy! Count me in as well as of today!

    Cheers!

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    1. FI Fighter: Thanks -- you made a great buy yourself!

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