>CUMMINS INDIA LIMITED (MERRILL LYNCH)

Reviving up for demand revival; new Buy

■ Initiate with Buy; PO of Rs423 implies 44% upside
Cummins India (CIL), a subsidiary of Cummins Inc, is a play on (1) rising demand for diesel genset (26% of FY09 sales) driven by growing need for uninterrupted power, (2) rising demand for engines (14% of FY10E sales) for industrial m/c led by infra sector, and (3) rising demand for CNG (compressed natural gas) engines driven by rise in natural gas supply, which is relatively cheap.

We expect CIL to re-rate to 15x P/E FY11E from 10.4x now, driven by increased visibility of 38% EPS growth in FY11E following a 13% drop in FY10E. Sustained QoQ sales recovery as seen in the Jun-09 quarter will be a key re-rating trigger. Our FY11E EPS is 41% higher than consensus led by cyclical recovery in exports.

■ Stronger domestic sales in Jun09 Q driving bullishness
We expect domestic sales of engines (40% of FY09 sales) and spare parts, including miscellaneous service (22% of FY09 sales), to be key earnings drivers going forward. We expect domestic sales to grow 17% in FY10E and 22% in FY11E on faster GDP growth. Recovery in domestic engine sales is evident from 44% QoQ growth in the Jun-09 quarter, after the sharp decline in Sep08-Mar09.

■ Exports decline hurts FY10E, but cyclical recovery ahead
CIL could report YoY EPS decline until Dec 2009, despite a QoQ recovery. This could be due to the over 60% plunge in exports (38% of FY09 sales). However, we expect exports to recover in FY11E given that (1) channel inventory reached trough level in Jun09 Q, (2) CIL exports typically recover after one year of decline and (3) We at BAS-ML expect Global GDP to rise 3.7% in 2010 vs -1% in 2009.

■ Key downside risk is adverse macroeconomic condition
There is a strong correlation between industrial growth and CIL’s P/E. It trades in a P/E band of 13-22x during the phase of 8-12% IIP growth. Thus, weak macro economy is a key risk to our PO based on P/E of 15x FY11E earnings.

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