Cummins Inc. (NYSE:CMI)’s stock has declined more than 20% over the past six months. Investors are concerned about the slowdown in China, softness in off-highway machinery markets caused by slumping commodity prices, and potentially peaking demand in the North American truck market. CMI serves a variety of cyclical markets around the world, and many of them have faced challenges in recent years. Investors are becoming increasingly impatient and uneasy wondering when the next leg of growth will occur. For long-term dividend growth investors willing to stomach some volatility, CMI’s 3.6% dividend yield is appealing given the dividend’s safety and growth potential.
Business Overview
CMI makes and services diesel and natural gas engines (44% of sales), electric power generation systems (12%), and engine-related component products (23%). The company also owns a number of distributors (21%) that provide aftermarket services and support the dealer network. Its main markets are highway & heavy-duty vehicles, construction, and general industrial markets, where it serves customers including Chrysler, Daimler, Volvo, PACCAR, Navistar, CNH Global, Komatsu, Ford, and more. International sales account for about 40% of CMI’s total revenue. CMI has been around for nearly 100 years and specializes in manufacturing the cleanest, most fuel-efficient and regulatory-compliant engines for many different types of vehicles and end markets.
The following pie chart highlights the Engine segment’s end market mix. The truck and bus market accounts for a little over half of its total sales.
Business Analysis
The engine market has numerous barriers to entry that have allowed CMI to build dominant market share positions across many of the regions it serves. Extensive regulatory requirements in developed markets (and increasingly developing markets as well) have imposed ever-stricter standards governing emission and noise. CMI’s products must comply with emission standards that the European Union, EPA, the California Resources Board, and other regulatory agencies have established for heavy-duty on-highway diesel and gas engines and off-highway engines. In order to comply with 2010 EPA emissions standards in the US, CMI invested over $170 million in R&D in 2007 and 2008.
The large investment required to remain compliant further solidified CMI’s market position as several competitors preferred to exit certain markets rather than invest to meet requirements. Caterpillar was the most notable peer that decided to exit the on-highway truck engine market in 2009 to focus on off-highway heavy-duty trucks, reinforcing the technological lead CMI has built in the on-highway engine market. (See our analysis of Caterpillar’s dividend here). Looking even further back, over half of the $2-3 billion CMI spent on R&D in the last 10 years has been invested in emission reduction technologies. With fuel representing a significant cost for many of CMI’s customers, CMI’s continual investments in fuel-efficient technology maintain its status as the premium engine vendor of choice.
The following chart is a bit dated, coming from CMI’s 2013 Analyst Day, but it highlights the company’s strong on-highway market share across the globe. CMI’s scale allows it to provide the best value proposition for its customers, keeping costs low through bulk purchases of materials and lean six sigma operations while having the significant capital necessary to establish production facilities and invest in R&D.
While CMI’s extensive engine knowhow and technology investments have played a substantial part in its growth, its contracts with customers and dealer network play equally important roles in maintaining its dominant position.
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