Cummins Pitch Final

CUMMININSTRONG(NYSE:CMI)

AlexKis,RobertOlechowski,AndyAronson,RileyTaylorNovember22nd,2015

CurrentPrice:$98.70TargetPrice:$142.87Commitmenttoemissionsstandards,improvementinoperations,andgeographic&productdiversityshouldoutweighanycyclicalweakdemandintheglobaltruckandenginemarket.

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AlexKis,RobertOlechowski,AndyAronson,RileyTaylor CumminsPitch

PitchOverviewCompanyDescriptionCumminsInc.iswasfoundedin1919inColumbus,Indiana;withover96years of operations the company has gained the dominant position indesign, manufacturing and servicing of diesel and gas engines, enginerelated component products, as well as electric power generationsystems.Itiscurrentlystructuredunder4divisions:engine,components,powergenerating,anddistribution.Itcurrentlyoperatesin190countries,has approximately 600 company owned and independent distributorlocations,and7200dealerlocations.Cumminsisthebiggestproducerofenginesandengine-relatedproducts,withmarketcapitalizationof20.59B,whereaveragesizeintheindustryis1.17B.

ThesisHighlights ExcellenceinEmissionStandardsCMI is one of the two main powerhouses in the Industrial EquipmentspacebesidesCAT.Intermsofinnovation,CMIisinaclassofitsown.TheQSF (lowhorsepower)engine linealready satisfies theEUandEPA low-emissions regulations. Additionally, the QSK (land drilling) engine linesatisfiesthe2018EPAstandards.CMIhasastrongfocusonlowemissionsinitiatives. In conjunction with the National Highway Traffic SafetyAdministration(NHTSA),CMIissupportingthenationalfuelefficiencyandgreenhouse gas emission regulations for medium and heavy-dutycommercialvehicles.

GeographicandProductDiversityCummins is able to hedge company risk by being present in essentiallyeverymajormarketintheworld.Thiswasobservedjustthispastquarter,where Brazil took over a 40% hit on revenues, but a strong NorthAmerican market balanced the problem for Cummins. Additionally,Cummins hedges any individual product risk by maintaining such adiversifiedportfolio.

ImprovedOperationsCMIisfocusedonimprovingmargins,enteringtheOEMmarket,andexpandingtheirpresenceinstronginternationalmarkets.For2015,totalEBITmarginacrossallsegmentsisexpectedtoincreaseto13.5%-14%upfrom13.2%in2014.CMIhasagoodholdontheOEMmarketforcommercialvehiclesandindustrialmachinery.Recentlytheyhaveannouncedaroundoflayoffsaswellasaninitiativetoreviewtheefficiencyofeachmanufacturingplant.Theseimprovementsshouldcarryintofutureyearswhendemandpicksbackupagain. ShareholderFriendlyCummins is in the midst of aggressively restructuring their equity. Acombinationof largesharerepurchasesand increasingdividendpayouts

Buy

PRICETARGET:

$136.66

CURRENTPRICE:

$98.70

CompanyInformation

INDUSTRY: ENGINES

MARKETCAP: 20.20BN

SALES: 19.84BN

BETA: 1.68

Price-BasedMultiples

EV/EBITDA: 6.72

EV/EBIT: 8.04

EV/SALE: 1.02

RelevantInformation

52WEEKH-L:$151.25-$97.41

EPS: 3.74

DIVIDENDYIELD: 2.79%

DEBT/EQUITY: 19%

PRICE/EARNINGS: 11.94

NETMARGIN: 8.75%

DEBTRATING: A

CURRENTRATIO: 2.22

ROE: 21.28%

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areexpectedtocontinueenhancingvalueforshareholders.CMIhasnot

lowereditscashdividendsinceFebruaryof2008;atsaidtime,thecashdividendwas$0.125pershare.AsofJuly2015,themostrecentquarterlycashdividendis$0.975pershare.In2014,CMIrepurchased4.8million shares for $670million. In 2015 YTD, the companyhas repurchased3.7million shares for$514millionandplanstoreturn38%ofitsoperatingcashflowtoshareholdersthroughdividendsandadditionalsharerepurchases.

ThesisRisks RegulationsandSynergiesMainriskstoCumminsaredelayedemissionregulations inUSAandEuropeaswellasaslow-downinthe developing countries especially China and India. As every manufacturing company Cummins isexposedtounforeseenqualityproblemsornecessitytorecallsomeproducts.Supplyshortagesareanadditional threat to the company well-being because of single-sourcing strategy. Materials andcommoditycostcannegativelyaffectoperationalandfinancialperformance.HighM&Aactivitycreatesa necessity to utilize planned synergies; failure todo somay greatly impact companyoperations andROI.Additionally,anoveralleconomicdownturnwillhaveadverseeffectoncompanyoperations.

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CompanyOverview

Cumminswasfoundedin1919inColumbus, Indianaas one of the first diesel engine manufacturers.Cummins has evolved to become a world leader inthedesign,manufacturing,distribution,andservicingof diesel and natural gas engines. They are dividedinto four complementary segments: Engine,Components, Distribution, and Power Generation.These segments are mutually beneficial, as theyshare customers, strategic partners, brandrecognition, and information to improveperformanceineachoftheirownmarkets.

In terms of revenues, Engine accounts for 45%,Components 21%, Distribution 22%, and PowerGeneration 12%. Currently, Cummins’ fastest-growingsegmentisDistribution,wheretheyrecentlycompletedthreeofmanyacquisitionsthathavebeeninthepipelineforthepastseveralyears(moreM&Agrowthisexpecteddowntheroad).IntermsofEBIT,Engine leads with 48%, followed by Components with 27%, Distribution with 19%, and PowerGenerationwith6%.

EngineSegment:Cummins produces diesel and natural gas powered engines for both on-highway and off-highwayapplications.Cumminsprovidessuperiorenginetechnologyintermsandfuelefficiencyandgreenhousegas(GHG)emissions,wheretheyareaheadofthecurveonregulatorycompliance.

On-highwayapplicationsaccountforabout65%ofrevenueinthissegment.Applicationsincludeenginesfor long-haul (also known as heavy-duty ortractor-trailers) trucks, medium-duty trucksand buses, recreational vehicles (consideredlight-duty), and light-duty consumer trucks(such as the Dodge Ram 2500). Heavy dutyengines account for about 29% of thesegment’s revenues, followed by medium-duty with 23%, and light-duty with 13%.Cummins holds the largest internationalpresence on-highway with its medium-dutytrucks, where about 45% of revenues comefrom international markets. Heavy-duty andlight-duty applications have internationalrevenuesof15%and5%,respectively.

Cummins sees most of its competition in itson-highway applications from Detroit Diesel,Volvo, and Navistar for heavy-duty and

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medium-duty applications. Additionally, they sell mainly to Paccar, Volvo, and Freightliner for theseapplications.Competitionforlight-dutyapplicationscomefromtheDetroitbigthreeautomakers(Ford,GM,andChrysler).CumminssellstoChryslerintheNorthAmericanmarketfortheDodgeRamlineofvehiclesandtoFordfortheBraziliantruckmarket.

Off-highwayapplicationsincludeconstructionandagriculture(13%ofrevenues);mining,marine,oilandgas (15%),andstationarypower (7%).Mostoff-highwayapplicationsaremuchmorediverse thantheon-highwayapplications,asenginescanrangefromanywherefrom49to5,100horsepower.CaterpillarisCummins’maincompetitionoff-highwayandtheirmaincustomersareKomatsu,Hitachi,andTerex.

ComponentsSegment:ThecomponentssegmentcomplementstheenginesegmentinthatCumminsdesignsandmanufacturesparts and systems for servicing their own engines as well as other companies’ engines. Their majorcomponents include after-treatment solutions (also known as emissions solutions), turbochargers,filtration systems, and fuel systems. Cummins is leading the industry when it comes to adhering toemissions regulations, which comes mainly from the efficiency and technology embedded in theiremissions solutions and turbocharges. About 60% of Cummins revenues in this segment come fromNorthAmerica,withtheother40%stemmingfrominternationalmarkets.

Their emissions solutions make up about 46% percent ofrevenues in this segment. These technologies range fromoxidationcatalysts,particulatefilters,andoxidesofnitrogen(NOx) reduction systems. Cummins holds over half of themarketshare in theseproducts inNorthAmericaandabout27%inEurope,theirmaincompetitionconsistingofTenneco,Emcon, and Eberspaechar. These emission solutionstechnologiesarefoundmostlyintheirownengines,buttheyarealsosoldtoITEC,Navistar,andVolvo.

After emissions solutions, turbochargers account for about24% of revenues in their components segment. Cumminsturbochargers provide critical air handling for engines,includingvariablegeometry turbochargers, inorder tomeetchallenging performance requirements and worldwideemissions standards. They primarily serve the NorthAmerican, European, Asian, and Brazilian markets. They

competeonlywithBorg-WarnerHoneywell in this space, and sell toVolvo, Scania, Iveco, andDetroitDiesel.

Filtrationmakesup about 21%of the revenuesof this segment. Cumminsoffersover 8,300productsincludingair filters, fuel filters, fuelwater separators, lube filters, andhydraulic filters. Theymaintainmany of the filters under the Fleetguard brand (including the NanoForce engine air filter), sellingproducts inover160countriesallover theglobe.Theirmain competitorsareDonaldsonandClarcor,Mann,&Hummel.Theyaretheworldwideleaderinfiltrationtechnologiesfordieselapplications;theirmaincustomersincludeITEC,CNH,andDeere.

Finally,theirfuelsystemsmakeupabout9%ofthecomponentssegment’srevenues.Theydesignandmanufacturenewandreplacementsystemsmainlyfortheirmediumandheavy-dutyon-highwayengineapplications.

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DistributionSegment:The distribution Segment is the fastest-growing segment at Cummins. Over the past two years, theyhavemadeseveralacquisitionsofpreviousjoint-venturedistributors.CurrentlyCumminsisexperiencingabout 20% sales growth in this segment. Distributionsupports the restof theirbusiness,as it ishow they funneltheirproductstomarket.Theymaintain34company-ownedand8joint-venturedistributorstoservicetheirendusersinover400locationsallovertheglobe.

Sixty-eight percent of the revenues in this segment comefrom markets outside North America. Their distributionmarketsareas follows:NorthandCentralAmerica;Europe,CIS and China; Asia Pacific; Middle East; Africa; India; andSouth America. The distribution segment is responsible formanagingwholly-ownedandpartiallyowneddistributors,aswellasindependentdistributors.Distributionfocusesonthefollowingbusinesses inwhichtheyserviceand/ordistributethe full range of Cummins’ products: Parts & Components(37%);PowerGeneration (22%);Engines (21%);andService(20%).

CumminscompetesmainlywithDonaldsonwithinthissegmentaswellasmanyofthecompetitorswhocompete in other parts of Cummins’ business. The Distribution segment mainly services Engine andPowerGenerationend-users,smallerOEMs,andotherfacilities(likehospitals,utilities,andfactories).

PowerGenerationSegment:Within their Power Generation segment, Cummins designs and manufactures engines, alternators,electronics (controls, transfer switches), and gensets. They are an industry leader, #1 or #2 in allcategoriesofPowergeneration(alongwithCAT).Theysellstoarangeofendconsumers,whetheritbehospitals, RVs, electric utilities, or wastewater treatment. Sixty-one percent of their revenues in thissegmentarefrominternationalmarkets.Theirproductsusuallyfallintothreeoverarchingapplications,andthereare fourdifferentcategoriesofproductswithinpowergeneration.

The applications for the Power Generation includestationaryconstant-usepower,distributedgeneration,andmobilepowersolutions.MobilepowersolutionsaremostoftenusedinthecaseofRVs,wherepowerisneededfromsome other source than the drivetrain. Constant-use anddistributed gen are applications that generate a muchlarger output than mobile solutions; the distinctionbetweenthetwoarisingthatdistributedgenispowerthatis turnedon/offveryoften(generation isdistributedovercertain parts of the day). Cummins sells gensets tohospitals or electric utilities in a developing countries toturn on or off as needed (such as in the event of anemergency or an unreliable electric grid). Constant-useapplicationismoreoftenpresentinfactoryapplications.

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The categorieswithin thePowerGeneration segment includepower systems,powerproducts,powersolutions, and generator technologies (mainly alternators). Power products (57% of revenue) aregenerators for commercial and consumer applications between 2kW to 1MW (1MW powersapproximately1,000homes).Powersystems(22%ofrevenue)aredieselfuelbasedgeneratorsetsoveroneMW;theyusuallyareparallelssystemsandtransferswitchesforcriticalprotectionofapplications(i.e.hospitals,datacenters,wastewatertreatmentplants).Inthegeneratortechnologycategory(16%ofrevenue), theydesign,manufacture,sell,andservicesA/Cgenerator/alternatorproducts (internallyandtoothercompanies).Finally,powersolutions,whichmakeup5%oftherevenueofthissegment,mainlyincludenaturalgasgenerationfordistributedgenerationbetween300kWand2,000kW.

Cummins’competitionfortheirgensetsinthissegmentmainlycomesfromKohler,Caterpillar,Generac,andTognum.Ontheotherhand,theirmaincompetitorsforalternatorsstemsfromABBandEmerson.

ManagementOverview

Since facing a Volkswagen-like emissions scandal in 1998, Cummins has entirely reworked theirmanagement team. The current Chairman and CEO, Tom Linebarger, has been with the company insome capacity since 1998. Beginning as the Vice President of Supply Chain Operations, LinebargerworkedhiswaytoChiefOperatingOfficerandPresidentofCumminsbeforetakingonhiscurrentroleeffective January 1st, 2012. Under Linebarger, Cummins has shifted much of their focus towardsincreasingefficiencyintheirdistributionchannels.Thiscanbeseeninthelargenumberofdistribution-related acquisitions made in recent years. This point will be discussed more in the “ImprovedOperations”sectionbelow.

Cummins’ExecutiveCompensationProgramisdesignedtorewardlong-termsustainablegrowthofthecompanyandshorter-termshareholderprosperity.TwoofthemainmetricsusedtorewardexecutivesareROEandROANA,whichisdefinedasEBITdividedbyaveragenetassetsinthecompany’sDEF14A.

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As illustrated above, Cummins believes that executive compensation should measure management’sability to balance short-term and long-term goals appropriately. The chart above exhibits that totalcompensation is in linewith total shareholder return, and the chart on the right shows a consistenttrendbetweentotalcompensation,ROE,andROANA.Therearemanychecksandbalancesinplacetoprevent executives from skewing the company to achieve higher compensation. Yearly third partycompensationrestructuring,targetcompensationcaps,andconflictingcompensationdriversareafewexamples.

Additionally, Cummins has a strong commitment to building leadership and a cohesive internationalimage.AsCumminsexpands internationally, it searcheseachnewmarket forpromising individuals toundergoan18-monthexecutiveeducationprograminordertotrainnewleaders.Theperksofhavingsuch a rigorous program include higher congruence between international markets, strongerunderstandingoflocalmarkets,andthepossibilitytoexpandfurther.

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IndustryNews

NorthAmericaClass8Backlog-to-BuildRatioTheClass8truckbacklog-to-buildratio,whichmeasuresthetimebetweenordersanddelivery,droppedto4.9monthsinSeptemberfrom5.5inAugustasdailybuildratesincreasedslightly.Theratiohasbeenabove fourmonths, the levelatwhich truckmakers raiseproduction, sinceNovember2013.But, it isdown from 7.9 months in December and at the lowest level since October 2014. A surge in ordercancellationsandrisingretailinventoriesmaycurbbuildsasmanufacturerbacklogsarere-evaluated.

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TruckMarketLikelytoPeakin2015withEconomicOutlookEasingTheheavytruckmarketwilllikelypeakin2015,saysFTRAssociates,as2016forecastswerecutonlowereconomic projections. The 2016 heavy-truck factory shipment forecastwas reduced 2.7% to 279,000units and by 5.6% to 259,800 in 2017. A strong dollar, global economic weakness and depressedcommodity prices have slowed industrial production, PMI, and economic projections for 2015 andbeyond. FTR says a pickup in housing or foreign trade could lead to a higher performance than itforecastsfor2016.

TruckIndicatorsPointtoCyclicalPeakNorth America preliminary heavy-truck orders for July fell 19.5% from a year earlier to 23,920 units,accordingtoFTRAssociates.That'sthehighestsinceMarch,asafewlargefleetsplacedordersearlierthanthenormalpeak-orderingseasonwhichstarts inOctober.Ordersrose21.3%fromJune, thefirstsequential gain in sixmonths, vs. a five-year average decline of 1% in July. Ordersmay slow for thebalance of the seasonally slower summer, yet backlogs are healthy and support production through2015.

CompanyNews

CumminstocutjobsasweakglobaleconomyhurtssalesCumminspostedalower-than-expectedquarterlyprofitandsaiditwouldlayoffupto2,000peopleasglobaleconomicweaknesscontinuedtoweighonitsinternationalsales.

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Sharesofthecompanyfellmorethan8percent.Itsaidmostofthejobcuts,whichwouldaffectnearly4percentofitsworkforce(ofabout54,000),wouldtakeplacebytheendof2015anddeliverannualizedsavings of $160 million to $200 million. During a conference call with analysts, executives said thecompanyexpectedfull-yearsalestobeflattodown2percent,comparedwithitspreviousforecastofariseof2percentto4percent.

ChiefExecutiveOfficerTomLinebargersaidinastatementthatindustryordersinBrazilandChinawereatmultiyearlows,withnosignthatthesemarketswillreboundsoon.Revenuefellalmost6percentto$4.62billionfrom$4.89billion.Analystshadexpected$4.91billion.ThecompanysaidNorthAmericansaleswereup4percent,butinternationalsalesplunged18percent.

Salesofenginesforheavy-dutytrucksinNorthAmerica,however,weredown9percent,andCumminslowereditsforecastforthesizeofthatoverallmarketin2015by4,000unitsto286,000.Theheavy-dutytruckbusinesshadpreviouslyremainedresilientevenwhileinternationalsaleshadfaltered.Inmorningtrading, Cummins shares were down 8.4 percent at $102.70. Shares of Navistar International Corp,whichbuysheavy-dutytruckenginesfromCummins,weredownnearly13percentat$12.24.

<<http://www.reuters.com/article/2015/10/27/cummins-results-idUSL1N12R0UQ20151027>>

CumminsEarns“A”CreditRating(CMI)Cummins(NYSE:CMI)hasearnedan“A”creditratingfromanalystsatMorningstar.Theresearchfirm’s“A”ratingindicatesthatthecompanyisalowdefaultrisk.Theyalsogavetheirstockathreestarrating.

Cummins (NYSE:CMI) tradedup 0.35%on Tuesday, hitting $107.23. 982,057 shares of the company’sstockwereexchanged.Cumminshasa52-weeklowof$99.76anda52-weekhighof$151.25.Thestockhasamarketcapof$18.94billionandaP/Eratioof11.48.Thefirmhasa50daymovingaveragepriceof$110.93anda200-daymovingaveragepriceof$126.45.

Thecompanyalsorecentlydisclosedaquarterlydividend,whichwillbepaidonTuesday,December1st.Investors on record on Friday, November 20th will be given a dividend of $0.975 per share. Thisrepresents a $3.90 annualized dividend and a yield of 3.65%. The ex-dividend date is Wednesday,November18th.

<<http://dcprogressive.org/2015/11/03/cummins-earns-a-credit-rating-cmi/>>

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StrengthsImprovedOperationsIn the most recent quarter, Cummins missed their earnings estimates by 7.8%, and the stock priceplummeted nearly 10% the day of the earnings call. Most analysts still believe Cummins will“outperform”, but they have lowered their target price estimates. Regardless of the slightly morebearish outlook, we believe that the current fear in the market combined with forward lookingimprovedoperationsprovidesaveryattractivebuyingopportunity.

Several factorshaveworked in tandem toprovide suchweakQ3 results. Internationally, demandhasmostly been down for commercial vehicles. Some of theworstmarkets have been Brazil and China,while India has surged forward with demand, hedging against the other markets. The continuouslystrengthening dollar has helped further decrease demand for American products. Cummins sufferedfrom a weak product mix recently, which can be explained by the strong shift towards improvingoperations,specificallyinthedistributionchain.

Intheveryshortterm,Cumminsplanstoterminate2,000positions,whichwillreduceannualcostsbybetween$160and$200million.

Looking forward, Cummins is looking to improve company-wide margins by heavily improving theirdistribution segment. To date, the distribution segment still only comprises 21.42% of Cummins’revenue. Thedistribution segment is comprisedof over 6,500 global locations that sell Cummins’ fullproduct line. Last year,Tom Linebarger stated inan interview that theinterconnectivity of thedistribution chain is ofgrowing importance toCummins. Linebargerstated that “it is theexpectation thatcustomers can get just asgoodserviceinWestAfricaas they can in the Gulf ofMexico”. It is importanttothe company to keepinternational operationswell integrated with bothCummins’ company imageand the foreign nation’soperating environment.International operations,including distributioncenters, are mostly operated by locals; there are only about 100 Cummins expatriates around theworld. A large portion of the distribution centers are joint-ventures to lower costs, butmany of thedistributionfacilitieshavebeenpurchasedoutright.ThisnetworkofcentersbecomesmoreimportantasCumminsrelies lessontheirenginessegment. Incomingyears,thecomponentssegmentwillbecome

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increasingly important. As emissions standards become more stringent, consumers relying oncompetitors’ engines will have to turn to Cummins for servicing and components that will reduceemissions in the short-term.This in turnwill attractmore customers toCummins’ engines,whichareconvenientlylocatedinthesamedistributioncenters.

Currently,marginsonthedistributionsegmentaresurprisinglylowduetolargerecentacquisitions.Notall of the acquisitions have had time to experience streamlined operations, butwe expect asmarketconditionsturnaroundandthedistributionchainhastimetosettlein,thecompanyshouldexperiencemuchhighermarginsduetotheincreasedefficiency.Asmentionedinthemanagementoverview,TomLinebarger, the current CEO, has a lot of experience with the operational side of Cummins. Thedistribution segment is beingpositioned topromote synergy throughout the company. In the comingmonths, Cummins could start employing more debt purposed towards material acquisitions. AsCummins is currentlyoneof the lowest levered companies in the industry, and the company’s targetdebt/EBITDAratiowillonlyriseto1.5x-2.0x,thisisseenasastrongpositive.Theaveragedebt/EBITDAontheindustryis3.49x,andCMIhasamuchhighercreditratingthanmostofitscompetitors.Cumminshas the free cash flow to reduce future debts, and assuming the company’s international segmentsbegintoshowsignsofimprovement,itwouldbeasmartdecisiontoutilizedebttogrowthedistributionsegment.

ApositiveshiftinthemarketwillamplifytheimprovementsthatCumminshasbeenmakinginternally.The company is prepared for higher demand in their main geographical segments including manyemergingmarkets.

ExcellenceinEmissionsStandardsAsmentioned in the “ManagementOverview” section, Cummins experienced an emissions cover-upscandalin1998.Sincethattime,Cumminshasturnedaroundtobecomeanindustryleaderinadheringtoandsupportingfutureemissionsinitiatives.SomuchsothatithasbecomeacompetitiveadvantagetoCummins.

Cummins has made emissions to be a core part of their business. In their components segment,emissions solutions/aftertreatment systems make up almost half of their revenues. In many cases,Cummins issellingtheirproprietaryemissionssolutions foruseontheircompetitor’sengines,suchasVolvoandNavistar.Althoughstricterregulationsdobringwiththemmorecosts,Cummins isuniquelypositioned.

Cumminsinnovationinthefieldisunparalleled.ItwasthefirsttoreceivecertificationforfollowingtheEPA’s2014GHGstandardforheavy-dutydieseltrucks.Thiscertificationwasdueinparttotheimmenseamount of technology surrounding Cummins’ heavy-duty engine. It is equipped with an XPI high-pressurecommon-railfuelsystem,VariableGeometryTurbocharger,andanaftertreatmentsystemwithadieselparticulate filter and selective catalytic reduction.Cumminsenginesall adhere to the currentstandards,themostrecentcertificationcomingthispastJunefromtheCaliforniaAirResourcesBoardstatingthatCummins6.7LturbodieselmetLow-EmissionVehicleIIIstandards.

Inthecaseofstricterregulations,Cumminswouldbenefit inthattheyarealreadyaheadofthecurve.Theyarelargeenoughthattheycouldbearthecosttoimprovetheirenginesquicklyinthemarket,astheyhaveproven in thepast.Cumminsalsobenefits frombeingacomponentsseller in that theycanalso sell their superior emissions solutions in the event of a tightening in regulations.Many of theircompetitorshaveadirectrelianceonCumminsfortheirtechnology.

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Two-thousand fourteenwasan importantyear forCummins. Itwas the firstyear inwhich theyrolledout their new sustainability objectives. These objectives detailed reduction inGHG emissions by 25%(from2005levels)by2015,reductioninwaterwasteby33%,andachievinga95%internalrecyclingrate(from a current rate of 83%). This programdemonstrates Cummins commitment to the environmentbeyondjustthetechnologytheyputintotheirengines.

ThispastOctober,CumminsopenedtheirSeymourTechnicalCenterforhigh-horsepowerengines.Thisplant in Columbus, Indiana focuses on developing technology for their engines in the 500 to 5,100horsepower range.As EdPence,VicePresident andGeneralManagerof thehigh-horsepower enginebusiness,says,“Withourlaser-focusonmeetingtheneedsofourcustomers,thistechnicalcenter isatremendous advantage in our quest to alwaysbebetter, faster, and first. This addition enhancesourSeymour site, which is now truly an industry-leading facility for engine design, testing, andmanufacturingwithworld-class credentials.” Alongwith this technical center, 12 new test cells havebeen installed at the Seymour plant,where they canmeasure fuel efficiency, engine endurance, andnear-zeroemission.TheSeymourtechnicalisjustonesmallexampleofCummins’overallcommitmenttomaintaincutting-edgeinnovation.

GeographicandProductDiversityCummins has a unique global growth strategy. The company penetrates new markets through jointventures. If the venture is successful Cummins deploys more and more capital and usually ends upacquiringitspartner.Thisstrategyisveryeffectivebecauseitreducesintegrationcostsafterthemergeris over. The distribution segment was able to grow at a rate of over 20% mainly due to successfulacquisitions in foreign markets. In order to minimize costs of international expansion, the companymainly employs local employees. In China, out of the 9000employeesCummins employsonly 40 areexpatriates.

<<https://www.pwc.com/us/en/ceo-survey-us/2014/assets/tom-linebarger.pdf>>

Whilesomecompaniesinthetruckingindustry had difficulties in 2014,Cummins recorded itsbestyear in itshistory, despite a decline incommercial truck sales. The gainswere accomplished despite asignificantdecline inbothheavy- andmedium-duty truck sales. Cummins’success is attributed the ongoingglobal strategy of diversification intoother enginemarkets, such as powergenerationandmarine.

As part of its growth strategy,Cummins invests in businesses inseveralcountriesthatcarryhighlevelsriskssuchasChina,Brazil,India,Mexico,Russia,andcountriesintheMiddleEastandAfrica.At thesametime, thegeographicdiversityandbroadproductandserviceofferingshavehelpedlimittheimpactfromadropindemandinanyoneindustryortheeconomyofanysinglecountryontheconsolidatedresults.

Although Cummins has investments in many markets all around the world, it has little exposure tocurrencyrisksbecauseitfocusesonreinvestingthecashinthemarketwhereitwasgenerated.Thetotal

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ofcash,cashequivalentsandmarketablesecuritiesheldbyforeignsubsidiarieswas$1.4billionin2014,thevastmajorityofwhichwaslocatedintheU.K.,China,Singapore,BelgiumandIndia.Thegeographiclocation of the cash andmarketable securities aligns well with Cummins’ growth strategy. Cumminsmanagescash requirements consideringavailable fundsamong itsmanysubsidiaries throughwhich itconducts business and the cost effectiveness with which those funds can be accessed. As a result,Cumminsdoesnotanticipateany local liquidity restrictions topreclude thecompany fromfunding itstargetedexpansionoroperatingneedswithlocalresources.

IfCumminswas todistribute its foreigncashbalances totheU.S.or toother foreignsubsidiaries, thecompanywouldberequiredtoaccrueandpayU.S.taxes.Forexample,Cumminswouldberequiredtoaccrue and pay additional U.S. taxes if it repatriated cash from certain foreign subsidiaries whoseearnings ithasassertedarepermanentlyreinvestedoutsideoftheU.S.Atpresent,Cumminsdoesnotforeseeaneedtorepatriateanyearningsfromthesesubsidiaries for which it has asserted permanentreinvestment.

International expansion helps Cummins to benefitfrom lowerproductioncosts fromcountriessuchasChina,IndiaandBrazil,whereCumminsmanufactureengines, generators and components for the localmarket, and have developed excellent localsuppliers. Cummins’ efforts have resulted insignificantly reducing the cost of purchasedmaterialsandservicesduringthelastsixyears.

International expansion also helped Cummins toreduce its R&D costs. The company is performingsignificant analysis work at its technical center inIndia.

Cumminswasalsoabletonegotiatefavorablecost-sharingarrangementswithOEMcustomersandjointventure partnerships worldwide. These initiatives helped Cummins to continue to be a technologyleader, while maintaining its research and engineering expense at approximately 3 percent ofconsolidatednetsales.

The Power Generation segment is focusing on attaining leadership positions in allmajor commercialgenerator set markets globally, including growth in market share in European, Middle Eastern andAfricanmarkets and penetration gains in power electronics and controls, such as automatic transferswitchesandswitchgear.

The Distribution segment is growing through the expansion of the aftermarket parts and servicebusinessbycapitalizingonitsglobalcustomerbaseandfastgrowthmarketsinChina,IndiaandRussiaaswellastheMiddleEast.

ShareholderFriendlyItishardtoignorethemovementsCumminsmakestocontinuetoenhancevaluefortheirshareholders.CumminshasnotdecreaseditsdividendsinceFebruaryof2008,whenitwas$0.125pershare.AsofJuly2015,thisdividendwas$0.975pershare.Recently,CumminswasnamedbyMarketWatchasoneofthetop ten dividend stocks. This, coupledwith their 1 billion dollar stock buyback program, signals theirstrongcommitmenttoshareholders.

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Currently,Cummins’dividendyieldiscloseto4%.Thisisverystrongintoday’s low interest rateenvironment. The question arises,though, if Cummins can maintainthis dividend in the coming years.Compared to 2014 and 2015,Cummins’ planned capitalexpenditures are very low. Thisimplies that management issatisfied with their position in thecurrentmarket and they have thecapacity to meet future demand

forquitesometime.Withcashinyearstocomenotbeingtiedupincapitalexpenditures,itislikelythatCummins can maintain their current dividend levels. Of course, if the next cyclical downtown isequivalenttotheoneexperiencedin2008,itismorelikelythattheywillhavetocutdownondividends.DividendsasapercentageofassetsforCumminsreached3.2%bytheendof2014,andtheyareonpacetodistributedividendsequalto3.9%ofassetsfor2015.Also, on November 10th, 2015, Cummins approved a 1 billion dollar stock buyback program. Thisprogramwill start following the conclusionof their last 1billionbuybackprogram, initiated in Julyof2014.TomLinebargerstatedattheannouncementofthebuyback,“Bymakinggoodstrategicchoices,adjusting our cost structure and quickly and operating our business well during periods of weakdemand, we will position Cummins for stronger performance when markets improve, as we havedemonstrated in prior cycles.” Cummins stock buyback programs display their commitment to returnvaluetoshareholdersevenintimesofeconomicdownturn.

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Risks

Werecognize6majorriskstoCumminscontinuousgrowthof itsbusiness.Therearemanymorerisksembedded inmanufacturing businesses and systematic risks that companies are not able to diversifyagainst.However,inouropinion,thefivemostimpactfulriskstoCumminsfinancialperformancewouldbe: inability to utilize synergies from recent acquisitions; failure to adjust in timely manner to thegovernment regulations; insourcing by truck andOEMsmanufacturers of thework currently done byCummins;vulnerabilityfromsingle-sourcestrategy;andincreasingpressurefromglobalcompetitors.

InabilitytoutilizesynergiesfromrecentacquisitionsAbility to smoothly incorporate operations of recently acquired entities is essential to future growth,costs savings, and an effective supply chain. Acquiring the remaining shares of distributors in UnitedStates and Canada is very important to incorporate all possible cost savings to bemore competitive.Focusingespeciallyonkeyemployeeretention,consolidationofexpenses,eliminatingredundancies,aswellasintegratingalltechnology.Furthermore,delaysinimplementationsoftheacquisitionplansmayadversely affect CMI operations in many outlooks: short, medium, and long term. Additionally,Cumminsisexposedtogovernmentapprovalsthatmayormaynotbegranted.Finally,averyimportantoccurrence in the acquisition process was the departure of key management staff (during sometakeovers);withoutthosepeople,thecompanyislosingapartofitspotentialcompetitiveadvantage.

FailuretoadjustintimelymannertogovernmentregulationsAsamanufacturer,CMIhastocomplywithverystringentandquickly-changinggovernmentregulationsin every country it operates. This aspect is extremely important to the engine segment,which is themain revenuedriverand ismostexposed to regulations.Asmentioned inouranalysis,CMI isalreadypreparedwithenginesthatcomplywithregulationsthataretobeimplementedin2016,howevereverydelay of this regulation will give its competitors more time to respond and additional costs savings.Furthermore, regulations are changing very frequently and it is very possible that CMI will have todesignnewengines inorderto fulfillnextregulationsthatshouldbeeffective in2020.Thisadditionalcostmay affect financial performance because Cumminswould be forced to increase R&D expenses.Thoseexpensesare inevitable,however,anadditionalwrinkle is thesizeofCMI,whichcanmake theimplementation more complicated. For example, the preparation of different designs for differentmarkets.

Vulnerabilitytosupplyshortagesbecauseofsingle-sourcesupplierstrategySinceover55%oftotaltypesofpartsweresinglesourcedin2014,CMIis very exposed to supply shortages. Even though establishedpartnerships are with credible, long-standing suppliers this situationexposes company to idle time thatwould effectively bring a financialloss. In the situation where one supplier will be unable to fulfill itscommitment finding the new one might take few weeks or evenmonths.This risk is real,and inouropinion,manyanalystsdiminish itstrategicimpact.

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InsourcingbytruckandOEMsmanufacturersMost big CMI customers including Volvo, PACCAR, Navistar and Chrysler have their own enginemanufacturing capabilities and despite that they have chosen to outsource production of certainenginestoCummins.Duetochangingmacroeconomicoutlookordifferentcorporatestrategythismaychange in the future.Outflowof those customerswouldgreatly affect the revenue streamaswell ascoststructure,becausemanyplantsmaybecomeunderutilized.

IncreasingpressurefromglobalcompetitorsAsmentioned in theearlierpoint,manyofCummins’clientsarealso itscompetitors.Suchasituationcreates constant pressure on lowering selling prices as well as increasing product quality. Manycompanies thatbuy fromCumminshave the capabilities to competewith its enginebranch thatmayleadtodecisiontoceasecooperationwithCMIandbeginningofthein-houseproduction.

Furthermore, other engine producers compete with the company for contracts with OEM producerswhichcreatesaconstantstruggletocutcostswithoutdecreasingquality.

HoltLens

The current stock price would make sense only if Cummins’ CFROI would drop drastically to a levelbelow its discountrate. This isunrealistic becauseCummins has beenconstantly beendelivering value to itsshareholders.Moreover,Cummins isa mature anddiversified company and for that reason it is unlikely that the CFROIwill drop somuch in the next 5years.

According to Credit Suisse Holt, Cummins is likely to outperform for two main reasons: improvedoperating margins andstrongassetturns:

Cummins has beenconstantly improving itsoperating margins since2003. That can beattributed to bettermanagement and to atransitioning towardsproducts with higher

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margins.

Asset turns have beenvery stable for Cummins.Thisproves thatCumminsmanaged assets andinventories efficiently.Cummins asset turns are15% better thanCaterpillar’s (their largestcompetitor).

Even assuming a huge decrease in CFROI the company seems to be undervalued by at least 15%.Althoughthisdropisunrealistic,itjustprovesthatthedownsidebyinvestinginCumminsisextremelylimited.

2012 2013 2014 t+1 t+5 t+10

CFROI% 14.76 11.71 11.70 7.27 5.94 5.53

Real Asset Growth%

11.34 10.44 4.14 3.71 2.82 2.69

DiscountRate 4.78 3.92 3.75 3.66

Date post:	22-Jan-2018
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Cummins Pitch Final

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