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Cummins India is a good long-term buy, but you can wait for the valuations to get more attractive…

Cummins India is the country’s largest manufacturer of engines. Its strength lies in the fact that it is a 51 per cent subsidiary of Cummins-USA, which gives it access to the latter’s technology. Further, its parent has decided to source engines and generators from Cummins India, a decision that has the potential to increase its revenue multi-fold in the coming years. Currently 70 per cent of the company’s revenue comes from the domestic market and 30 per cent from exports.

Strengths.
The company manages to keep competition at bay with its technological superiority, especially in the mid- to high- horse power engine segments.

Concerns.
In recent times, demand has weakened both in the domestic and the international market. In the domestic market there has been a downturn in the capex cycle. Demand has weakened considerably from sectors such as commercial realty, infrastructure, telecom and industrials.
Exports are also expected to weaken in FY12 owing to slowing growth in much of the advanced world. The company’s management has revised its revenue projection for FY12 downward from around 20 per cent to 10-15 per cent.
EBITDA margin is also expected to contract owing to higher costs of inputs such as pig iron and copper. In the low horse power segment, Cummins India faces competition from the unorganised segment and from Chinese imports. Increase in the price of diesel could also affect the demand for engines and generators adversely.

Turnaround signals.
The demand for engines and generators will pick up as soon as there is a rebound in the infrastructure segment and in industrial capex. If the global economy improves, that could also lead to its parent company sourcing more engines from Cummins India. Investors in this stock could also benefit if the parent makes an open offer for the stocks of Cummins India, as has already happened in the case of Siemens and Crompton.

Valuation.
The stock is now trading at a 12-month trailing PE of 22.07, which is higher than its five-year median PE of 24.13. Its price-earnings to growth (PEG) ratio comes to 0.80. This is a good long-term buy, but wait for valuation to turn more attractive.