Exposure can be considered in the stock of Cummins India with an investment horizon of about one-two years. At current market price, the stock trades at about 17 times the likely FY-08 earnings per share.
Buoyant demand from user industries, planned addition the capacities and strong growth prospects on both the domestic and export fronts underscore our recommendation.
Also, the company's efforts to improve efficiency with the help of cost-reduction initiatives are a positive.
Power generation to drive growth
The contribution from the power generation business in the domestic market is likely to drive Cummins India's growth.
For the nine months ended December 2006, there was a 40 per cent increase in the revenue contribution.
Further, on the back of frequent power deficits and increasing demand, the need for alternative sources of power such as DG sets, would continue to propel the segment's growth.
While we expect Cummins to sustain its market share in the high horsepower range, it could face stiff competition from such players as Kirloskar Oil Engines and Greaves Cotton in the lower horsepower range.
Growth in the industrial business unit, however, has been mixed. While it can be attributed mainly to increased sale of engines, which find application in various equipment used in road construction, and mining, the water well compressor business remained a laggard.
However, with the increase in outlay towards the NHDP (National Highway Development Project), increase in the capex of user industries and the Government's thrust on infrastructure development, the company's revenue visibility is likely to strengthen.
The automotive segment, which has more than doubled its revenue contribution, is likely to fortify future growth.
Our optimism stems from the positive demand environment for high horsepower trucks and engines, which will witness a growth in demand given the Supreme Court directive for enforcement against overloading.
Cummins' partnership with Tata Motors for providing engines for the latter's heavy trucks is likely to remain the growth driver for this segment.
In addition to this, the company's effort to consolidate its position in the CNG (compressed natural gas) bus market is also encouraging.
On the export front, revenues are likely to sustain given the increased outsourcing from the parent company.
Nevertheless, any further appreciation of the rupee could exert more pressure on the export earnings. Besides this, any slowdown in the US economy could affect the earnings.
Concerns
A rise in crude oil prices is likely to affect Cummins negatively as that would put pressure on the profitability of the user industries, leading to a fall in demand for Cummins' products.
Cummins also faces the risk of increased competition from global players, given the low import duty on engines.
The delay in the capex plan of user industries or an unprecedented rise in raw material cost is a downside risk to our recommendation.