North American And China Demand Decline Will Impede Profitability

Key Takeaways

• Declining North American truck demand and EPA uncertainties threaten revenue, margins, and profitability due to market and regulatory volatility.
  
• Challenges in the China market and delays in Accelera's profitability could impact international revenue and long-term earnings projections.
  
• Cummins' strategic initiatives in power generation, sustainable energy, and partnerships indicate strong growth potential despite market challenges, supporting earnings resilience and expansion.

Catalysts

Offers various power solutions worldwide.

• The forecasted decline in the North American heavy-duty truck market with units projected to be flat to down 10% year-over-year suggests a potential decrease in revenue, pressuring overall company profitability.
  
• Cummins faces challenges in the China market, with anticipated heavy and medium-duty truck demand projected down 5% to up only 10%, reflecting uncertainties that could impact international revenue and earnings.
  
• The strategic reorganization of the Accelera segment resulted in significant charges and, despite ongoing investments, the business is not on track to reach EBITDA breakeven by 2027, potentially impacting projected earnings.
  
• The market outlook for medium-duty trucks in North America anticipates a reduction between 5% to 15% in market size from 2024 levels, which may lead to underperformance against revenue expectations and compress margins if cost adjustments are not made swiftly.
  
• Persistence of uncertainties regarding EPA regulations and prebuy phenomena in North American heavy-duty markets create risks for volume and price volatility, potentially affecting margins and leading to earnings variability.

Cummins Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on Cummins compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Cummins's revenue will decrease by 3.3% annually over the next 3 years.
• The bearish analysts assume that profit margins will shrink from 11.6% today to 7.8% in 3 years time.
• The bearish analysts expect earnings to reach $2.4 billion (and earnings per share of $18.0) by about April 2028, down from $3.9 billion today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 21.7x on those 2028 earnings, up from 10.1x today. This future PE is greater than the current PE for the US Machinery industry at 19.7x.
• Analysts expect the number of shares outstanding to grow by 0.51% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.46%, as per the Simply Wall St company report.

Cummins Future Earnings Per Share Growth

Risks

• Cummins anticipates continued strength in its power generation markets, which is expected to support revenue growth, especially driven by the demand for data centers.
  
• The company is strategically investing $200 million to expand its manufacturing capacity, which could enhance operational efficiency and potentially boost net margins.
  
• Cummins’ multi-solution Destination Zero strategy, including the HELM engine platforms offering fuel flexibility, positions it to capture market share in sustainable energy sectors, positively impacting earnings.
  
• The partnership with Daimler Trucks & Buses and others in the Amplify Cell Technologies joint venture could create new revenue streams from battery cell production in the U.S.
  
• Despite market challenges, Cummins' record 2024 financial performance and guidance for improved profitability and cash flow in 2025 suggest resilience and potential for earnings growth.

Valuation

• The assumed bearish price target for Cummins is $303.64, which represents one standard deviation below the consensus price target of $359.6. This valuation is based on what can be assumed as the expectations of Cummins's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $460.0, and the most bearish reporting a price target of just $240.0.
  
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be $30.8 billion, earnings will come to $2.4 billion, and it would be trading on a PE ratio of 21.7x, assuming you use a discount rate of 7.5%.
  
• Given the current share price of $288.57, the bearish analyst price target of $303.64 is 5.0% higher. The relatively low difference between the current share price and the analyst bearish price target indicates that the bearish analysts believe on average, the company is fairly priced.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.