DGI Adventure – 11-25-2015 Investment Thesis – Cummins Inc (CMI) – $98.00/share

Please visit the core
philosophies
article on my
investment thesis process
for a full explanation of the components of this
article.

Dividend Cycle

CMI should go ex-dividend sometime in mid-February. The Q4
dividend for 2015 hasn’t been paid yet, but the ex-dividend date was 11/18/15,
so I’ve missed out on this quarter. I’m disappointed too, because it’s a hefty
dividend: $0.975/share.  It was raised an
impressive 25% from $0.78/share between Q2 and Q3, so I’m not expecting an
increase for a while. But I do expect one next year some time. CMI is a dividend
Contender, having raised dividends for 10 consecutive years.

Investment

CMI is hovering at a 3 year low, closing
yesterday at $98.68. The stock has been absolutely punished over the last year
and a half. I’ve had my eye on CMI for a while, and told myself if it got below
$100/share I would buy. Of course it did…before the ex-dividend date…and I didn’t
do anything about it like an idiot. For $1,476.95 I can buy 15 shares at
$98.00. That’s a pretty small delta for a long wait till the next ex-dividend, but
I can always buy more right? Why am I so interested? Let’s take a look.

The QC (Quantitative
Case)

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LOL (Limit Order
Logic) – $98.00

CMI has been hovering around $98 since about November 12th.
Considering the current share price is so historically low, you have to go a
long way back to find support levels below this, and the consolidation period
over the last few weeks is shaping up to potentially be its own support level
going forward. There are some very old peaks from 2011 and 2012 in the $96-97
mark and some troughs around $86. I’m not inclined to wait around to see if it
wants to push $86. That’s just too far. It seems much more likely to start to
go up from here. If it does go down to test those old lows, I will probably be
buying more.

QWaF (Qualitative
Warm and Fuzzy)

Diesel engines are really useful. They drive trucks, they
run generators, they make shit happen. You know who’s really good at building
diesel engines? Cummins.

Even though this is a narrow market niche, the company has a
pretty well-structured revenue stream. Half of sales come from over the road
diesel engines, where the company controls 40% and 70% of the North American heavy
and medium duty engine market share (data from Morningstar). The other half of
sales come from components (think R&M), distribution and the mobile power
generation (think generators) segments.

Diesel engines aren’t very easy to make. It’s especially
difficult to make diesel engines that meet stringent US EPA emissions
regulations (just ask Volkswagen). Cummins has heavily invested in R&D over
the years and continues to do so. The result is that the company should be able
to continue to provide products that meet these regulations much more efficiently
than any upstarts. US emission regulations are some of the most stringent in
the world, and the rest of the world is following suit. Europe is getting more
and more strict and both China and India have serious air quality problems that
are likely to precipitate emissions regulations. Cummins’ technological advantage
should translate into global growth for the brand.

The R&D is an important investment, but it doesn’t eat up
all the cash, and the company has a very comfortable debt level (less debt than
cash is ALWAYS a good thing). In fact, capex has outstripped earnings growth
(33% 10 year CAGR). This is an incredibly profitable company and it’s
continuing to grow in spite of “headwinds” discussed below. I don’t understand
why the share price is so depressed.

CPR (Cold and Prickly
Risks)

No seriously. Why is the stock down so much? Strong dollar?
I guess.

Just kidding. There are reasons of course, and
yeah the exchange rate is partly to blame. The emissions regulations that the
company is constantly trying to keep up with could change so drastically that
they can’t keep up anymore. Emerging market growth is not a foregone conclusion.
China’s growth is ostensibly slowing down. The company did mention slowing
demand in the most recent (Q3) earnings report. I suppose it’s very possible
they’re in a down cycle of a cyclical business. They look to be in pretty good
shape to me, and they managed to raise dividends in the last down cycle (which
was a doozy), so I’m giving them the benefit of the doubt.

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