>CUMMINS INDIA (EDELWEISS)

■ Export revenues drag on the topline; merger propels margin
Cummins India’s (KKC) Q2FY10 revenues, at INR 4.8 bn (ex-Cummins Sales and Services, CSS), were down 39% Y-o-Y, as export revenues (~40% in FY09) collapsed 80% Y-o-Y, to INR 723 mn in the quarter. Additionally, revenues were lower by INR 700 mn in the quarter due to an illegal strike at one of the production facilities. KKC revenues, including CSS, fell 23% Y-o-Y, to INR 6.2 bn, although the same is strictly not comparable, as Q2FY09 numbers do not include CSS financials. EBITDA margins (including-CSS) improved 310bps Y-o-Y, to 18.3%; ex CSS, they improved 100bps Y-o-Y, to 13.0%, indicating that margins on CSS could be ~36% for the quarter. Margins were higher (ex CSS), mainly due to lower commodity prices and efforts at cost reduction initiatives.

■ Order intake yet to pick up; enquiries on the rise
According to the management, domestic business continues to see rebound in activity. In Q2, the industrial segment continued to grow, driven by improvement in orders from the manufacturing end-user industries like mining and construction. In the domestic business, power generation continues to remain the dominant business vertical with 50% contribution to revenues, while the industrial segment contributed 15-20% and auto business 10%. According to the management, the domestic business is likely to see 10-15% growth from Q4FY10.

■ Domestic business to grow; revising estimates upwards
After the rebound in activity in the past two quarters, the management indicated that their capex plans are back on track. Over H2FY09, the company had slowed down its capacity expansion undertaken in Phaltan, Maharastra. Apart from expanding the services portfolio, the company is also expanding capacities for 5.9 litre engines at Phaltan. Investment for the same is likely to be ~INR 1 bn spread over 2-3 years.

■ Outlook and valuations: Superior business model; upgrade to ‘BUY’
While revenues are likely to decline in FY10, we believe the outlook for FY11E is significantly better driven by the domestic business. We maintain our estimates for FY11E, upside risks to the same cannot be ruled out on account of superior growth in revenues and margins. At our consolidated EPS estimates of INR 20.2 and INR 24.4, the stock is trading at P/E of 18.5x and 15.4x for FY10E and FY11E, respectively. We believe KKC has a robust business model, backed by a strong product profile leading to impressive return ratios. We upgrade our recommendation on the stock to ‘BUY’, and rate it ’Sector Outperformer’ on a relative return basis

To read the full report: CUMMINS INDIA