Saturday, July 14, 2012


Profitability supported by cost optimization – a widening moat
In FY12, Cummins India (KKC) curtailed its EBITDA margin decline at 200bp to 16.9%, despite slowing sales (up 3% YoY) and rising input costs. Raw material (RM) costs rose only 3% YoY despite 16% YoY rise in pig iron prices, which forms over 50% of RM cost. This commendable achievement is a result of increased indigenization and cost optimization measures:

(i) RM imports have declined significantly from 29-30% of revenues in FY07-08 to 20% in FY12. Also, within RM, component imports have declined to 69% of RM consumed (from 77% in FY08) and share of semi-finished components have increased to 19% from 5% in FY08.

(ii) Cost optimization measures like ACE III (Accelerated Cost Efficiency) are expected to generate savings of INR2.3b till 2014 by reducing the total cost of ownership of direct materials by 20%. TRIMs (Total Reduction in Indirect Materials & Services) targets to reduce the direct cost of ownership in indirect materials by 10% over 3 years.

Expect a meaningful increase in capex
In its recent analyst meet, KKC stated that capex in FY13/14 is expected at ~INR6.5b each, which is meaningful given FY12 gross fixed assets at INR9.7b. Capex in FY12 increased to INR2.1b, and stood at 28% of the opening gross fixed asset. A large part of the incremental capex (~65%) pertains to the India Technical centre and India Office Campus, which will also be shared with group companies and thus KKC will earn lease income (IOC to commence in April 2014). This will likely dilute return ratios (FY12 ROE at 28%) and remains an area of concern. Capital commitments stood at INR4.3b in FY12, up from INR550m in FY11; thus, expect a steep increase in FY13 capex.

60-liter engine has revenue potential of INR2.6b over 5 years
KKC’s FY12 Annual Report states that the 60-liter engine will be an INR2.6b opportunity over 5 years. This is meaningful given that KKC's domestic engine sales in FY12 is ~INR12.6b. Construction for high horsepower QSK60/23 engines in India commenced in FY12 at Phaltan megasite. We believe that going forward, there exists possibilities that some of the new products will be manufactured / exported by Cummins Inc, while KKC retains the marketing rights in India.

To read report in detail: CUMMINS INDIA