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SELL CMP Rs370 Target Rs332 Downside 10%

For important information about YES Securities (India) Ltd. and other disclosures, refer to the end of this material. 1

Cummins India Ltd Result Report | Sector: Capital Goods June 18, 2020

HIGHLIGHTS

KKC’s EBITDA declined 61% yoy (‐53% vs est.) owing to sales de‐growth of 21.5%, negative operating leverage & unfavorable mix. PBT declined 42% yoy to Rs1.2bn, however Adj. PAT was down 13% yoy as higher other income & deferred tax reversal negated lackluster margin show (lowest ever in last 15 years).

Mgmt. expects domestic market recovery could take at least 8‐10 months while export recovery especially from Europe, Middle East & LATAM would be far difficult due to supply disruptions, trade embargoes & sluggish demand.

Commercial & residential real estate activities expected to remain sluggish while data centers, hospitals & critical power applications to support Powergen biz. Distribution is expected to recover in Q2FY21 while rail segment (40% of industrial sales) to lead industrial biz recovery by FY21 end.

Our View

We remain highly skeptical on KKC’s margin recovery to 11%+ over FY20‐FY22 due to, i) Unfavorable product mix (increasing share of industrials within domestic sales, delay in export revival), ii) Pricing pressure in India worse than global levels (LHP/ HHP pricing significantly below inflation levels in domestic market), iii) Competition getting fierce amidst slowing demand and iv) KKC’s inability to keep control over fixed costs. We also expect contraction in margins of Export biz in mid‐term, foreseeing incremental competition over time.

Valuation

During FY05‐14, KKC traded at average 1‐yr forward P/E multiple of 17x & delivered average RoE / Core RoIC of 30%/32% respectively. Over FY14‐20, KKC’s valuations re‐rated significantly (traded at average 1‐yr forward P/E multiple of 32x) in anticipation of strong growth but it disappointed with flat earnings CAGR & average RoE / Core RoIC of 20%/17%.

Retain ‘SELL’ with TP of Rs332 at 17x FY22E EPS. Deteriorating earnings quality (non‐core income as % of PBT at 45% in FY22E) & weakening return metrix justify our ratings & target multiple.

Risk to our call

KKC could be the key beneficiary of CPCB IV+ norms in a long‐term, apt & quick adoption of the same remains risk to our call.

Financial Summary (Consolidated) Y/e 31 Mar (Rs mn) FY18 FY19 FY20 FY21E FY22E Revenues 51,119 56,973 51,915 41,980 49,334 yoy growth (%) 0.1 11.5 (8.9) (19.1) 17.5 EBITDA 7,329 8,691 5,892 3,761 4,911 EBITDAM (%) 14.3 15.3 11.3 9.0 10.0 Adjusted PAT 7,118 7,426 7,056 4,371 5,409 yoy growth (%) (9.2) 11.1 (2.3) (39.7) 23.8 EPS (Rs) 24.1 26.8 26.2 15.8 19.5 P/E (x) 15.3 13.8 14.1 23.5 19.0 P/BV (x) 2.5 2.4 2.3 2.3 2.2 EV/EBITDA (x) 13.7 11.3 16.1 25.0 19.1 Net D/E (x) (0.1) (0.1) (0.2) (0.2) (0.2) ROE (%) 14.4 14.0 10.7 5.0 7.0 ROCE (%) 16.7 17.7 16.7 9.8 11.7

Source: Company, YES Sec – Research

Stock data (as on June 18, 2020) Sensex: 34,208 52 Week h/l (Rs) 788 / 280 Market cap (Rs/USD mn) 102467 / 1346 Outstanding Shares 277 6m Avg t/o (Rs mn): 577 Div yield (%): 3.8 Bloomberg code: KKC IN NSE code: CUMMINSIND Stock performance

1M 3M 1Y Absolute return 16.4 (16.3) (48.4) Shareholding pattern (As of Mar’20 end) Promoter 51.0% FII+DII 37.6% Others 11.2% ∆ in earnings estimates FY21e FY22e EPS (New) 15.8 19.5 EPS (Old) 16.6 19.8 % change (5%) (1%)

UMESH RAUT Lead Analyst [email protected] +91 7874052571

AMAR AMBANI, Sr. President, Head of Research

[email protected]

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CUMMINSIND Sensex

https://euromoney.com/brokers


Cummins India Ltd

CON‐CALL HIGHLIGHTS FY21 Guidance Management has refrained from giving out any guidance for FY21 due to uncertainties

related to COVID‐19 pandemic.

Segment Outlook The export run rate will normalize depending on various variables and so is difficult to predict

as different countries are coming back at a different rate. For instance, China is back in an accelerated manner and so KKC has a pipeline of orders coming in from China and it would take some time to fulfil those orders as the company needs to ramp up its operations in India. Whereas other markets like Europe are tightly shut down and are slowly beginning to ramp up. According to the management it’ll likely take at least 6‐12 months before it recovers back to a strong level

According to the management, out of the 4 businesses distribution will recover the fastest mainly because even if no new equipment has bought one still needs to maintain the existing equipment and KKC gets quite a bit of income from maintenance contracts, and sale of spare parts. The second area would be a toss‐up between industry and exports depending on the recovery of global economy post covid‐19 pandemic and depends to a certain extent on the revival schemes and packages set up by the government of different countries to boost their economies. The currency having weakened has made KKC’s position a little better, and management thinks that KKC will have some advantages for a couple of quarters due to the depreciation of currency. Power gen domestic market will be lagging because it has already started a downcycle with the economy and there is going to be a continued pressure on Power gen according to the management.

Cummins has 4 manufacturing locations around the world namely China, India, the US, & the UK. Primary supply source for the whole world for Cummins comes from India as the US uses the products made for domestic purpose and so there is not much export out there. In the rest of the world and most of China, the products are sold only in china, and the UK makes very few large generating sets. Going forward KKC is introducing many more products, aggressively pursuing more markets and the cost base is getting more efficient as the rupee becomes weaker hence all the above factors show that in the long‐term Cummins will continue to depend more on India and exports will contribute more

As to the demand from the other markets, the management hopes that KKC can get incremental opportunities. And, it has the capacity, the scale, and the variety of products available in India to do the same. Therefore, this might open to new opportunities when the supply chains across the globe will deviate from China

Most of KKC’s customers are in the space of government, construction and manufacturing and as that economy picks up, only then the people will start buying capital goods. According to the management, it is going to take some time because lockdown is only likely to ease gradually, and as that eases up, people will start working, government will start spending on infrastructure, & things will get mobilized. And hence, on a very optimistic case it’ll at least take 3‐6 months to normalize

Covid‐19 impact KKC is slowly scaling up its operations at different locations. Different customers and

segments are coming up at different rates. Hence, mgmt. has no clarity on margins but would get a clearer picture in the upcoming quarters

In terms of capacity, KKC’s factories are opened to an extent of 50‐80%. KKC has 3 main supply chain clusters in India, one being the Chennai region, one in Maharashtra and the third in NCR. As these areas are affected significantly due to COVID‐19, KKC’s supply chain is facing disruptions. Overall, KKC would be around 35‐40% utilization compared to 65‐70% (pre‐covid level which is the normal production capacity utilization)


Cummins India Ltd

Receivables is an ongoing process at KKC, mgmt. said that they continued to work closely with their customers and in the down period, interaction with the customers was done daily to collect the money. Overall, past dues have gone up as government being KKC’s customers could not relieve money during the Covid period.

Focusing on cost rationalization KKC has taken payroll actions and deferred merit for all employees of the company. KKC is

looking at every aspect of fixed and variable costs of the company from a new perspective based on the demand scenario panning out and these numbers should be visible in the balance sheet from Q1FY21

Distribution expected to recover faster than other segments Distribution would come back faster than any other segment because even though

customers would not undertake new investments in machinery, maintenance, repair and servicing of the existing machinery would be required.

In PG business, some aspects of the export side are coming up a little faster than the domestic. Within the domestic PG biz, certain segments like hospitals, data centers, critical power applications will come back at much faster rate. Whereas in areas like commercial and residential real estates, will take a lot of time to ramp up depending on the large capex spend amid time of uncertainty

As far as the industrial segment is concerned, compressor segment would continue to remain weak as its demand is in cyclical downturn. Construction segment has dropped off significantly but, if govt plans on spending money on building roads and the MNREGA schemes kick in, then construction segment has an ability to bounce back. Rail segment is ramping up quickly as per the mgmt. Mining will bounce back quite quickly as it was slowed down for the current period due to labour unavailability. Marine & Defence segment will have a medium recovery period.

Export markets continue display softness but expected to ramp up Markets in export that has ramped up would be China, Vietnam, Indonesia and the US. All

other markets continue to lag as they are just getting out of the quarantine periods. Mgmt. believes that the rest of the markets will pick up by next 2 quarters.

Top 5 markets for the company continues to be Europe, Middle east, Africa, South East Asia and China. As these markets start opening more, there should be a positive trend in exports there. Top 5 markets would contribute to almost 65‐70% of the revenues.

Demand for HHP is more from China market. Mgmt. expects HHP products to ramp up faster as KKC products perform well for data centers and other critical segments. As those markets are reviving faster, KKC is seeing more exports there. LHP and MHP being widely used in industry and consumer applications are taking longer to recover.

Other highlights Other expenses were up by Rs100mn in Q4FY20 partially due to foreign exchange impact

(no one off item) which would be around Rs20‐25mn

FY20 domestic revenues were Rs37.7bn, out of which PG was Rs14.3bn, industrial was Rs9.75bn, auto segment was Rs200mn and distribution segment was Rs13.4bn. FY20 export revenues stood at Rs12.9bn, out of which HHP was Rs7.27bn, LHP was Rs4.8bn & spare parts were Rs800mn.

Out of the Rs9.75bn of industrial segment, construction contributes about 30%, compressors contribute about 15%, mining would be 8%, rail would be 40%, marine and others would be 7%

KKC expects the tax rate to hover around 24‐25% on a sustainable basis

Domestic PG sales breakup‐ HHP was Rs6.45bn, MHP was Rs4.2bn, LHP was Rs3.7bn

Market share of Cummins India: LHP: 23%, MHP: 43%, HHP: 54%


Cummins India Ltd

Result table (Standalone) (Rs mn) Q4FY20 Q4FY19 % yoy Q3FY20 % qoq

Total sales 10,528 13,404 (21.5) 14,534 (27.6)

EBITDA 667 1,718 (61.2) 2,158 (69.1)

EBITDAM (%) 6.3 12.8 (648.5) 14.8 (851.1)

Depreciation (308) (280) 9.9 (296) 4.1

Interest (49) (45) 8.2 (47) 5.2

Other income 898 692 29.7 723 24.2

PBT 1,208 2,085 (42.1) 2,538 (52.4)

Tax 13 (676) (101.9) (515) (102.5)

Adjusted PAT 1,221 1,409 (13.3) 2,023 (39.6)

Exceptional item (38) 0 (161)

Reported PAT 1,183 1,409 (16.0) 1,862 (36.5)

PATM (%) 11.2 10.5 72.4 12.8 (157.7)

EPS (Rs) 4.4 5.1 (13.3) 7.3 (39.6)


Cost analysis (Standalone) As a % of net sales Q4FY20 Q4FY19 bps yoy Q3FY20 bps qoq

COGS 65.0 65.8 (77.2) 65.1 (8.0)

Employee cost 13.3 10.0 328.3 9.7 358.8

Other expenses 15.3 11.4 397.4 10.3 500.3

Total costs 93.7 87.2 648.5 85.2 851.1


Results highlights: Sales declined 21.5% yoy to Rs10.5bn (‐14% vs our est.). Domestic & exports sales decreased

by 22%/20% yoy respectively. The de‐growth was on account of muted order bookings due to economic slowdown accentuated by Covid‐19 related lockdown which impacted revenue for the quarter.

COVID‐19 impact on Q4FY20 revenues at ~Rs1.9bn.

EBITDA stood at Rs667mn, down 61% yoy (‐53% vs our est.)

EBITDA margins came in at historical low of 6.3%, down 649bps yoy led by adverse mix & negative operating leverage.

Other income increased 30% yoy to Rs898mn led by rental income.

PBT declined 42% yoy to Rs1.2bn (‐30% vs our est.)

Deferred tax reversal of Rs2.4bn led to effective tax reversal of Rs13mn during Q4FY20

Adjusted PAT dropped by 13% yoy (‐6% vs our est) as higher other income & deferred tax reversal negated the poor operating performance.

During challenging times, NWC has improved marginally from 78days in FY19 to 75days in FY20.

Consolidated debt increased to Rs4.9bn in FY20 from Rs3.1bn in FY19.


Cummins India Ltd

Valuation Charts Deteriorating earnings/returns deserve Pre‐FY14 P/E trajectory


Trading P/B multiple closer to GFC crisis, like other industrial peers


EV/EBITDA multiple expansion was unwarranted between FY14‐20


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Cummins India Ltd

Financial Chart

PG growth revival hinges on CPCB4+ products & real estate recovery


Distribution remains only secular growth driver for KKC


Exports recovery likely to be delayed


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Cummins India Ltd

Industrial growth likely to be supported by rail segment


Within exports, LHP & HD segments were under severe pressure


Industrial growth driven by rail & marine segments


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Cummins India Ltd

Powergen revenues affected majorly from weakness in HHP market


Adverse mix has kept gross margin under check


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Cummins India Ltd

FINANCIALS Income statement (Consolidated)

Y/e 30 Mar (Rs mn) FY18 FY19 FY20 FY21E FY22E Total operating revenues 51,119 56,973 51,915 41,980 49,334 Growth (%) 0.1 11.5 (8.9) (19.1) 17.5 EBITDA 7,329 8,691 5,892 3,761 4,911 EBITDA margin (%) 14.3 15.3 11.3 9.0 10.0 Growth (%) (8.9) 18.6 (32.2) (36.2) 30.6 Depreciation & amortization 944 1,111 1,206 1,283 1,382 EBIT 6,385 7,580 4,686 2,478 3,528 EBIT margin (%) 12.5 13.3 9.0 5.9 7.2 Interest 152 168 210 234 246 Other income 1,613 2,351 2,575 2,368 2,478 Profit before tax 7,847 9,763 7,051 4,612 5,760 Tax 1,818 3,263 1,019 1,121 1,407 Associate income 659 926 1,223 880 1,056 Minority interest 0 0 0 0 0 Adjusted net profit 6,687 7,426 7,255 4,371 5,409 Extraordinary items (431) 0 199 0 0 Reported net profit 7,118 7,426 7,056 4,371 5,409 Adjusted net margin (%) 13.1 13.0 14.0 10.4 11.0 Diluted EPS (Rs) 24.1 26.8 26.2 15.8 19.5 Growth (%) (9.2) 11.1 (2.3) (39.7) 23.8

Balance sheet (Consolidated) Y/e 30 Mar (Rs mn) FY18 FY19 FY20 FY21E FY22E SOURCE OF FUNDS

Share capital 554 554 554 554 554 Reserve & Surplus 40,632 42,275 43,466 45,001 46,740 Total shareholder's funds 41,186 42,830 44,020 45,555 47,295 Minority Interest 0 0 0 0 0 Debt 2,568 3,126 4,893 5,053 3,549 Deferred tax liabilities/(assets) 1,402 2,432 2,265 2,166 1,670 TOTAL 45,156 48,387 51,178 52,774 52,513 APPLICATION OF FUNDS

Gross block 28,509 29,299 33,053 35,053 37,285 Less: Depn. and amort. 8,300 9,147 10,353 11,636 13,019 Net block 20,209 20,151 22,700 23,417 24,267 Capital WIP 387 1,585 800 800 1,200 Long term investments 7,085 4,682 2,559 2,425 2,425 Other long term assets 2,226 2,326 2,077 2,411 2,211 Inventories 5,444 6,329 5,772 5,176 5,677 Debtors 13,382 12,836 12,836 10,926 11,489 Cash & cash equivalents 4,709 7,381 12,353 13,861 12,510 Loans & advances 3,706 5,314 2,863 2,504 3,013 Total current liabilities 11,991 12,215 10,783 8,745 10,277 Net current assets 15,249 19,643 23,042 23,721 22,411 TOTAL 45,156 48,387 51,178 52,774 52,513


Cummins India Ltd

Cash flow statement (Consolidated) Y/e 30 Mar (Rs mn) FY18 FY19 FY20 FY21E FY22E

PBT 9,266 10,689 8,075 4,612 5,760

Depreciation 944 1,111 1,206 1,283 1,382

Others (1,664) (1,545) (1,783) (880) (1,056)

Tax Paid (1,835) (2,374) (1,623) (1,121) (1,407)

Changes in Working Capital (392) (2,349) 133 828 (41)

Net Cash from Operations 6,319 5,532 6,007 4,722 4,638

Capex (918) (2,741) (2,371) (2,334) (2,432)

Change in Investment 1,582 670 (1,163) 134 0

Others (2,004) 2,234 1,395 0 0

Net Cash from Investing (1,340) 162 (2,139) (2,200) (2,432)

Change in debt 0 558 1,767 160 (1,504)

Change in Equity 0 0 0 0 (0)

Others (4,696) (5,808) (5,890) (1,174) (2,053)

Net Cash from Financing (4,696) (5,251) (4,123) (1,014) (3,557)

Net Change in Cash 284 444 (255) 1,507 (1,351)

Free cash flow (FCF) 5,096 5,806 4,048 2,699 2,392

Ratio analysis (Consolidated) Y/e 30 Mar (Rs mn) FY18 FY19 FY20 FY21E FY22E

PROFITABILITY RATIOS

EBITDA Margin (%) 14.3 15.3 11.3 9.0 10.0

Adjusted net margin (%) 13.9 13.0 13.6 10.4 11.0

Return on invested capital (%) 14.4 14.0 10.7 5.0 7.0

Return on equity (%) 16.7 17.7 16.7 9.8 11.7

EFFICIENCY RATIOS

Asset Turnover 2.5 2.6 2.2 1.7 1.9

Debt to equity 0.1 0.1 0.1 0.1 0.1

Net debt to equity (0.1) (0.1) (0.2) (0.2) (0.2)

Interest coverage 42.0 45.2 22.3 10.6 14.3

Debtor days 95.5 82.2 90.2 95.0 85.0

Inventory days 38.9 40.5 40.6 45.0 42.0

Payable days 54.2 52.9 49.0 49.0 49.0

PER SHARE DATA

Diluted EPS (Rs) 24.1 26.8 26.2 15.8 19.5

BVPS (Rs) 148.6 154.5 158.8 164.3 170.6

DPS (Rs) 15.0 17.0 14.0 8.5 11.0

VALUATION RATIOS

P/E 15.3 13.8 14.1 23.5 19.0

P/BV 2.5 2.4 2.3 2.3 2.2

EV/EBITDA 13.7 11.3 16.1 24.9 19.1

Dividend Yield (%) 4.1 4.6 3.8 2.3 3.0


Cummins India Ltd

DISCLAIMER

Investments in securities market are subject to market risks, read all the related documents carefully before investing.

The information and opinions in this report have been prepared by YSL and are subject to change without any notice. The report and information contained herein are strictly confidential and meant solely for the intended recipient and may not be altered in any way, transmitted to, copied or redistributed, in part or in whole, to any other person or to the media or reproduced in any form, without prior written consent of YSL.

The information and opinions contained in the research report have been compiled or arrived at from sources believed to be reliable and have not been independently verified and no guarantee, representation of warranty, express or implied, is made as to their accuracy, completeness, authenticity or validity. No information or opinions expressed constitute an offer, or an invitation to make an offer, to buy or sell any securities or any derivative instruments related to such securities. Investments in securities are subject to market risk. The value and return on investment may vary because of changes in interest rates, foreign exchange rates or any other reason. Investors should note that each security's price or value may rise or fall and, accordingly, investors may even receive amounts which are less than originally invested. The investor is advised to take into consideration all risk factors including their own financial condition, suitability to risk return profile and the like, and take independent professional and/or tax advice before investing. Opinions expressed are our current opinions as of the date appearing on this report. Investor should understand that statements regarding future prospects may not materialize and are of general nature which may not be specifically suitable to any particular investor. Past performance may not necessarily be an indicator of future performance. Actual results may differ materially from those set forth in projections.

Technical Analysis reports focus on studying the price movement and trading turnover charts of securities or its derivatives, as opposed to focussing on a company’s fundamentals and opinions, as such, may not match with reports published on a company’s fundamentals.

YSL, its research analysts, directors, officers, employees and associates accept no liabilities for any loss or damage of any kind arising out of the use of this report. This report is not directed or intended for distribution to, or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction, where such distribution, publication, availability or use would be contrary to law, regulation or which would subject YSL and associates to any registration or licensing requirement within such jurisdiction. The securities described herein may or may not be eligible for sale in all jurisdictions or to certain category of investors. Persons in whose possession this document may come are required to inform themselves of and to observe such restriction.

DISCLOSURE OF INTEREST

Name of the Research Analyst : Umesh Raut

The analyst hereby certifies that opinion expressed in this research report accurately reflect his or her personal opinion about the subject securities and no part of his or her compensation was, is or will be directly or indirectly related to the specific recommendation and opinion expressed in this research report.

Sr. No. Particulars Yes/No

1 Research Analyst or his/her relative’s or YSL’s financial interest in the subject company(ies) No

2

Research Analyst or his/her relative or YSL’s actual/beneficial ownership of 1% or more securities of the subject company(ies) at the end of the month immediately preceding the date of publication of the Research Report

No

3 Research Analyst or his/her relative or YSL has any other material conflict of interest at the time of publication of the Research Report

No

4 Research Analyst has served as an officer, director or employee of the subject company(ies) No

5 YSL has received any compensation from the subject company in the past twelve months No

6 YSL has received any compensation for investment banking or merchant banking or brokerage services from the subject company in the past twelve months

No

7

YSL has received any compensation for products or services other than investment banking or merchant banking or brokerage services from the subject company in the past twelve months

No

8 YSL has received any compensation or other benefits from the subject company or third party in connection with the research report

No

9 YSL has managed or co‐managed public offering of securities for the subject company in the past twelve months

No

10 Research Analyst or YSL has been engaged in market making activity for the subject company(ies) No

Since YSL and its associates are engaged in various businesses in the financial services industry, they may have financial interest or may have received compensation for investment banking or merchant banking or brokerage services or for any other product or services of whatsoever nature from the subject company(ies) in the past twelve months or associates of YSL may have managed or co‐managed public offering of securities in the past twelve months of the subject company(ies) whose securities are discussed herein.

Associates of YSL may have actual/beneficial ownership of 1% or more and/or other material conflict of interest in the securities discussed herein.

YES Securities (India) Limited

Registered Address: Unit No. 602 A, 6th Floor, Tower 1 & 2, Indiabulls Finance Centre, Senapati Bapat Marg, Elphinstone Road,

Mumbai – 400013, Maharashtra, India.

Contact Details: +91‐22‐71123123 Email: [email protected] | Website: https://yesinvest.in

Registration Nos.: CIN: U74992MH2013PLC240971 | SEBI Single

Registration No.: NSE, BSE, MCX & NCDEX : INZ000185632 | Member Code: BSE – 6538, NSE – 14914, MCX – 56355 & NCDEX ‐ 1289 | MERCHANT BANKER: INM000012227 | RESEARCH ANALYST: INH000002376 | INVESTMENT ADVISER: INA000007331 |

AMFI ARN Code – 94338

Details of Compliance Officer: Name: Vaibhav Purohit, Email id: [email protected], Contact No‐+91‐22‐33479208

For important information about YES Securities (India) Ltd. and other disclosures, refer to the end of this material.

RECOMMENDATION PARAMETERS FOR FUNDAMENTAL REPORTS

Analysts assign ratings to the stocks according to the expected upside/downside relative to the current market price and the estimated target price. Depending on the expected returns, the recommendations are categorized as mentioned below. The performance horizon is 12 to 18 months unless specified and the target price is defined as the analysts’ valuation for a stock. No benchmark is applicable to the ratings mentioned in this report.

BUY: Potential return >15% over 12 months

ADD: Potential return +5% to +15% over 12 months

REDUCE: Potential return ‐10% to +5% over 12 months

SELL: Potential return

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