Cummins Pitch Final

CUMMIN IN STRONG
(NYSE:CMI)
Alex Kis, Robert Olechowski, Andy Aronson, Riley Taylor
November 22nd, 2015
Current Price: $98.70 Target Price: $142.87
Commitment to emissions standards, improvement in operations, and geographic & product
diversity should outweigh any cyclical weak demand in the global truck and engine market.

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Alex Kis, Robert Olechowski, Andy Aronson, Riley Taylor Cummins Pitch

Pitch Overview
Company Description
Cummins Inc. is was founded in 1919 in Columbus, Indiana; with over 96
years of operations the company has gained the dominant position in
design, manufacturing and servicing of diesel and gas engines, engine
related component products, as well as electric power generation
systems. It is currently structured under 4 divisions: engine, components,
power generating, and distribution. It currently operates in 190 countries,
has approximately 600 company owned and independent distributor
locations, and 7200 dealer locations. Cummins is the biggest producer of
engines and engine-related products, with market capitalization of 20.59
B, where average size in the industry is 1.17B.
Thesis Highlights
Excellence in Emission Standards
CMI is one of the two main powerhouses in the Industrial Equipment
space besides CAT. In terms of innovation, CMI is in a class of its own. The
QSF (low horsepower) engine line already satisfies the EU and EPA low-
emissions regulations. Additionally, the QSK (land drilling) engine line
satisfies the 2018 EPA standards. CMI has a strong focus on low emissions
initiatives. In conjunction with the National Highway Traffic Safety
Administration (NHTSA), CMI is supporting the national fuel efficiency and
greenhouse gas emission regulations for medium and heavy-duty
commercial vehicles.
Geographic and Product Diversity
Cummins is able to hedge company risk by being present in essentially
every major market in the world. This was observed just this past quarter,
where Brazil took over a 40% hit on revenues, but a strong North
American market balanced the problem for Cummins. Additionally,
Cummins hedges any individual product risk by maintaining such a
diversified portfolio.
Improved Operations
CMI is focused on improving margins, entering the OEM market, and
expanding their presence in strong international markets. For 2015, total EBIT
margin across all segments is expected to increase to 13.5%-14% up from
13.2% in 2014. CMI has a good hold on the OEM market for commercial
vehicles and industrial machinery. Recently they have announced a round of
layoffs as well as an initiative to review the efficiency of each manufacturing
plant. These improvements should carry into future years when demand
picks back up again.
Shareholder Friendly
Cummins is in the midst of aggressively restructuring their equity. A
combination of large share repurchases and increasing dividend payouts
Buy
PRICE TARGET:
$136.66
CURRENT PRICE:
$98.70

Company Information
INDUSTRY: ENGINES
MARKET CAP: 20.20 BN
SALES: 19.84 BN
BETA: 1.68
Price-Based
Multiples
EV/EBITDA: 6.72
EV/EBIT : 8.04
EV/SALE: 1.02
Relevant Information
52 WEEK H-L: $151.25 - $97.41
EPS: 3.74
DIVIDEND YIELD: 2.79%
DEBT/EQUITY: 19%
PRICE/EARNINGS: 11.94
NET MARGIN: 8.75%
DEBT RATING: A
CURRENT RATIO: 2.22
ROE: 21.28%

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are expected to continue enhancing value for shareholders. CMI has not
lowered its cash dividend since February of 2008; at said time, the cash dividend was $0.125 per share.
As of July 2015, the most recent quarterly cash dividend is $0.975 per share. In 2014, CMI repurchased
4.8 million shares for $670 million. In 2015 YTD, the company has repurchased 3.7 million shares for
$514 million and plans to return 38% of its operating cash flow to shareholders through dividends and
additional share repurchases.
Thesis Risks
Regulations and Synergies
Main risks to Cummins are delayed emission regulations in USA and Europe as well as a slow-down in
the developing countries especially China and India. As every manufacturing company Cummins is
exposed to unforeseen quality problems or necessity to recall some products. Supply shortages are an
additional threat to the company well-being because of single-sourcing strategy. Materials and
commodity cost can negatively affect operational and financial performance. High M&A activity creates
a necessity to utilize planned synergies; failure to do so may greatly impact company operations and
ROI. Additionally, an overall economic downturn will have adverse effect on company operations.

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Company Overview

Cummins was founded in 1919 in Columbus, Indiana
as one of the first diesel engine manufacturers.
Cummins has evolved to become a world leader in
the design, manufacturing, distribution, and servicing
of diesel and natural gas engines. They are divided
into four complementary segments: Engine,
Components, Distribution, and Power Generation.
These segments are mutually beneficial, as they
share customers, strategic partners, brand
recognition, and information to improve
performance in each of their own markets.
In terms of revenues, Engine accounts for 45%,
Components 21%, Distribution 22%, and Power
Generation 12%. Currently, Cummins’ fastest-
growing segment is Distribution, where they recently
completed three of many acquisitions that have been
in the pipeline for the past several years (more M&A
growth is expected down the road). In terms of EBIT,
Engine leads with 48%, followed by Components with 27%, Distribution with 19%, and Power
Generation with 6%.
Engine Segment:
Cummins produces diesel and natural gas powered engines for both on-highway and off-highway
applications. Cummins provides superior engine technology in terms and fuel efficiency and greenhouse
gas (GHG) emissions, where they are ahead of the curve on regulatory compliance.
On-highway applications account for about 65% of revenue in this segment. Applications include engines
for long-haul (also known as heavy-duty or
tractor-trailers) trucks, medium-duty trucks
and buses, recreational vehicles (considered
light-duty), and light-duty consumer trucks
(such as the Dodge Ram 2500). Heavy duty
engines account for about 29% of the
segment’s revenues, followed by medium-
duty with 23%, and light-duty with 13%.
Cummins holds the largest international
presence on-highway with its medium-duty
trucks, where about 45% of revenues come
from international markets. Heavy-duty and
light-duty applications have international
revenues of 15% and 5%, respectively.
Cummins sees most of its competition in its
on-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 these
applications. Competition for light-duty applications come from the Detroit big three automakers (Ford,
GM, and Chrysler). Cummins sells to Chrysler in the North American market for the Dodge Ram line of
vehicles and to Ford for the Brazilian truck market.
Off-highway applications include construction and agriculture (13% of revenues); mining, marine, oil and
gas (15%), and stationary power (7%). Most off-highway applications are much more diverse than the
on-highway applications, as engines can range from anywhere from 49 to 5,100 horsepower. Caterpillar
is Cummins’ main competition off-highway and their main customers are Komatsu, Hitachi, and Terex.
Components Segment:
The components segment complements the engine segment in that Cummins designs and manufactures
parts and systems for servicing their own engines as well as other companies’ engines. Their major
components 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 to
emissions regulations, which comes mainly from the efficiency and technology embedded in their
emissions solutions and turbocharges. About 60% of Cummins revenues in this segment come from
North America, with the other 40% stemming from international markets.
Their emissions solutions make up about 46% percent of
revenues in this segment. These technologies range from
oxidation catalysts, particulate filters, and oxides of nitrogen
(NOx) reduction systems. Cummins holds over half of the
market share in these products in North America and about
27% in Europe, their main competition consisting of Tenneco,
Emcon, and Eberspaechar. These emission solutions
technologies are found mostly in their own engines, but they
are also sold to ITEC, Navistar, and Volvo.
After emissions solutions, turbochargers account for about
24% of revenues in their components segment. Cummins
turbochargers provide critical air handling for engines,
including variable geometry turbochargers, in order to meet
challenging performance requirements and worldwide
emissions standards. They primarily serve the North
American, European, Asian, and Brazilian markets. They
compete only with Borg-Warner Honeywell in this space, and sell to Volvo, Scania, Iveco, and Detroit
Diesel.
Filtration makes up about 21% of the revenues of this segment. Cummins offers over 8,300 products
including air filters, fuel filters, fuel water separators, lube filters, and hydraulic filters. They maintain
many of the filters under the Fleetguard brand (including the NanoForce engine air filter), selling
products in over 160 countries all over the globe. Their main competitors are Donaldson and Clarcor,
Mann, &Hummel. They are the worldwide leader in filtration technologies for diesel applications; their
main customers include ITEC, CNH, and Deere.
Finally, their fuel systems make up about 9% of the components segment’s revenues. They design and
manufacture new and replacement systems mainly for their medium and heavy-duty on-highway engine
applications.

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Distribution Segment:
The distribution Segment is the fastest-growing segment at Cummins. Over the past two years, they
have made several acquisitions of previous joint-venture distributors. Currently Cummins is experiencing
about 20% sales growth in this segment. Distribution
supports the rest of their business, as it is how they funnel
their products to market. They maintain 34 company-owned
and 8 joint-venture distributors to service their end users in
over 400 locations all over the globe.
Sixty-eight percent of the revenues in this segment come
from markets outside North America. Their distribution
markets are as follows: North and Central America; Europe,
CIS and China; Asia Pacific; Middle East; Africa; India; and
South America. The distribution segment is responsible for
managing wholly-owned and partially owned distributors, as
well as independent distributors. Distribution focuses on the
following businesses in which they service and/or distribute
the full range of Cummins’ products: Parts & Components
(37%); Power Generation (22%); Engines (21%); and Service
(20%).
Cummins competes mainly with Donaldson within this segment as well as many of the competitors who
compete in other parts of Cummins’ business. The Distribution segment mainly services Engine and
Power Generation end-users, smaller OEMs, and other facilities (like hospitals, utilities, and factories).
Power Generation Segment:
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 all
categories of Power generation (along with CAT). They sells to a range of end consumers, whether it be
hospitals, RVs, electric utilities, or wastewater treatment. Sixty-one percent of their revenues in this
segment are from international markets. Their products usually fall into three overarching applications,
and there are four different categories of products within
power generation.
The applications for the Power Generation include
stationary constant-use power, distributed generation, and
mobile power solutions. Mobile power solutions are most
often used in the case of RVs, where power is needed from
some other source than the drivetrain. Constant-use and
distributed gen are applications that generate a much
larger output than mobile solutions; the distinction
between the two arising that distributed gen is power that
is turned on/off very often (generation is distributed over
certain parts of the day). Cummins sells gensets to
hospitals or electric utilities in a developing countries to
turn on or off as needed (such as in the event of an
emergency or an unreliable electric grid). Constant-use
application is more often present in factory applications.

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The categories within the Power Generation segment include power systems, power products, power
solutions, and generator technologies (mainly alternators). Power products (57% of revenue) are
generators for commercial and consumer applications between 2kW to 1MW (1MW powers
approximately 1,000 homes). Power systems (22% of revenue) are diesel fuel based generator sets over
one MW; they usually are parallels systems and transfer switches for critical protection of applications
(i.e. hospitals, data centers, waste water treatment plants). In the generator technology category (16%
of revenue), they design, manufacture, sell, and services A/C generator/alternator products (internally
and to other companies). Finally, power solutions, which make up 5% of the revenue of this segment,
mainly include natural gas generation for distributed generation between 300kW and 2,000kW.
Cummins’ competition for their gensets in this segment mainly comes from Kohler, Caterpillar, Generac,
and Tognum. On the other hand, their main competitors for alternators stems from ABB and Emerson.
Management Overview

Since facing a Volkswagen-like emissions scandal in 1998, Cummins has entirely reworked their
management team. The current Chairman and CEO, Tom Linebarger, has been with the company in
some capacity since 1998. Beginning as the Vice President of Supply Chain Operations, Linebarger
worked his way to Chief Operating Officer and President of Cummins before taking on his current role
effective January 1st, 2012. Under Linebarger, Cummins has shifted much of their focus towards
increasing efficiency in their distribution channels. This can be seen in the large number of distribution-
related acquisitions made in recent years. This point will be discussed more in the “Improved
Operations” section below.
Cummins’ Executive Compensation Program is designed to reward long-term sustainable growth of the
company and shorter-term shareholder prosperity. Two of the main metrics used to reward executives
are ROE and ROANA, which is defined as EBIT divided by average net assets in the company’s DEF 14A.

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As illustrated above, Cummins believes that executive compensation should measure management’s
ability to balance short-term and long-term goals appropriately. The chart above exhibits that total
compensation is in line with total shareholder return, and the chart on the right shows a consistent
trend between total compensation, ROE, and ROANA. There are many checks and balances in place to
prevent executives from skewing the company to achieve higher compensation. Yearly third party
compensation restructuring, target compensation caps, and conflicting compensation drivers are a few
examples.
Additionally, Cummins has a strong commitment to building leadership and a cohesive international
image. As Cummins expands internationally, it searches each new market for promising individuals to
undergo an 18-month executive education program in order to train new leaders. The perks of having
such a rigorous program include higher congruence between international markets, stronger
understanding of local markets, and the possibility to expand further.

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Industry News

North America Class 8 Backlog-to-Build Ratio
The Class 8 truck backlog-to-build ratio, which measures the time between orders and delivery, dropped
to 4.9 months in September from 5.5 in August as daily build rates increased slightly. The ratio has been
above four months, the level at which truck makers raise production, since November 2013. But, it is
down from 7.9 months in December and at the lowest level since October 2014. A surge in order
cancellations and rising retail inventories may curb builds as manufacturer backlogs are re-evaluated.

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Truck Market Likely to Peak in 2015 with Economic Outlook Easing
The heavy truck market will likely peak in 2015, says FTR Associates, as 2016 forecasts were cut on lower
economic projections. The 2016 heavy-truck factory shipment forecast was reduced 2.7% to 279,000
units and by 5.6% to 259,800 in 2017. A strong dollar, global economic weakness and depressed
commodity prices have slowed industrial production, PMI, and economic projections for 2015 and
beyond. FTR says a pickup in housing or foreign trade could lead to a higher performance than it
forecasts for 2016.
Truck Indicators Point to Cyclical Peak
North America preliminary heavy-truck orders for July fell 19.5% from a year earlier to 23,920 units,
according to FTR Associates. That's the highest since March, as a few large fleets placed orders earlier
than the normal peak-ordering season which starts in October. Orders rose 21.3% from June, the first
sequential gain in six months, vs. a five-year average decline of 1% in July. Orders may slow for the
balance of the seasonally slower summer, yet backlogs are healthy and support production through
2015.

Company News

Cummins to cut jobs as weak global economy hurts sales
Cummins posted a lower-than-expected quarterly profit and said it would lay off up to 2,000 people as
global economic weakness continued to weigh on its international sales.

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Shares of the company fell more than 8 percent. It said most of the job cuts, which would affect nearly 4
percent of its workforce (of about 54,000), would take place by the end of 2015 and deliver annualized
savings of $160 million to $200 million. During a conference call with analysts, executives said the
company expected full-year sales to be flat to down 2 percent, compared with its previous forecast of a
rise of 2 percent to 4 percent.
Chief Executive Officer Tom Linebarger said in a statement that industry orders in Brazil and China were
at multi year lows, with no sign that these markets will rebound soon. Revenue fell almost 6 percent to
$4.62 billion from $4.89 billion. Analysts had expected $4.91 billion. The company said North American
sales were up 4 percent, but international sales plunged 18 percent.
Sales of engines for heavy-duty trucks in North America, however, were down 9 percent, and Cummins
lowered its forecast for the size of that overall market in 2015 by 4,000 units to 286,000. The heavy-duty
truck business had previously remained resilient even while international sales had faltered. In morning
trading, Cummins shares were down 8.4 percent at $102.70. Shares of Navistar International Corp,
which buys heavy-duty truck engines from Cummins, were down nearly 13 percent at $12.24.
<<http://www.reuters.com/article/2015/10/27/cummins-results-idUSL1N12R0UQ20151027>>
Cummins Earns “A” Credit Rating (CMI)
Cummins (NYSE:CMI) has earned an “A” credit rating from analysts at Morningstar. The research firm’s
“A” rating indicates that the company is a low default risk. They also gave their stock a three star rating.
Cummins (NYSE:CMI) traded up 0.35% on Tuesday, hitting $107.23. 982,057 shares of the company’s
stock were exchanged. Cummins has a 52-week low of $99.76 and a 52-week high of $151.25. The stock
has a market cap of $18.94 billion and a P/E ratio of 11.48. The firm has a 50 day moving average price
of $110.93 and a 200-day moving average price of $126.45.
The company also recently disclosed a quarterly dividend, which will be paid on Tuesday, December 1st.
Investors on record on Friday, November 20th will be given a dividend of $0.975 per share. This
represents a $3.90 annualized dividend and a yield of 3.65%. The ex-dividend date is Wednesday,
November 18th.
<<http://dcprogressive.org/2015/11/03/cummins-earns-a-credit-rating-cmi/>>

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Strengths
Improved Operations
In the most recent quarter, Cummins missed their earnings estimates by 7.8%, and the stock price
plummeted 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 more
bearish outlook, we believe that the current fear in the market combined with forward looking
improved operations provides a very attractive buying opportunity.
Several factors have worked in tandem to provide such weak Q3 results. Internationally, demand has
mostly been down for commercial vehicles. Some of the worst markets have been Brazil and China,
while India has surged forward with demand, hedging against the other markets. The continuously
strengthening dollar has helped further decrease demand for American products. Cummins suffered
from a weak product mix recently, which can be explained by the strong shift towards improving
operations, specifically in the distribution chain.
In the very short term, Cummins plans to terminate 2,000 positions, which will reduce annual costs by
between $160 and $200 million.
Looking forward, Cummins is looking to improve company-wide margins by heavily improving their
distribution segment. To date, the distribution segment still only comprises 21.42% of Cummins’
revenue. The distribution segment is comprised of over 6,500 global locations that sell Cummins’ full
product line. Last year,
Tom Linebarger stated in
an interview that the
interconnectivity of the
distribution chain is of
growing importance to
Cummins. Linebarger
stated that “it is the
expectation that
customers can get just as
good service in West Africa
as they can in the Gulf of
Mexico”. It is important to
the company to keep
international operations
well integrated with both
Cummins’ company image
and the foreign nation’s
operating environment.
International operations,
including distribution
centers, are mostly operated by locals; there are only about 100 Cummins expatriates around the
world. A large portion of the distribution centers are joint-ventures to lower costs, but many of the
distribution facilities have been purchased outright. This network of centers becomes more important as
Cummins relies less on their engines segment. In coming years, the components segment will become

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increasingly important. As emissions standards become more stringent, consumers relying on
competitors’ engines will have to turn to Cummins for servicing and components that will reduce
emissions in the short-term. This in turn will attract more customers to Cummins’ engines, which are
conveniently located in the same distribution centers.
Currently, margins on the distribution segment are surprisingly low due to large recent acquisitions. Not
all of the acquisitions have had time to experience streamlined operations, but we expect as market
conditions turn around and the distribution chain has time to settle in, the company should experience
much higher margins due to the increased efficiency. As mentioned in the management overview, Tom
Linebarger, the current CEO, has a lot of experience with the operational side of Cummins. The
distribution segment is being positioned to promote synergy throughout the company. In the coming
months, Cummins could start employing more debt purposed towards material acquisitions. As
Cummins is currently one of the lowest levered companies in the industry, and the company’s target
debt/EBITDA ratio will only rise to 1.5x-2.0x, this is seen as a strong positive. The average debt/EBITDA
on the industry is 3.49x, and CMI has a much higher credit rating than most of its competitors. Cummins
has the free cash flow to reduce future debts, and assuming the company’s international segments
begin to show signs of improvement, it would be a smart decision to utilize debt to grow the distribution
segment.
A positive shift in the market will amplify the improvements that Cummins has been making internally.
The company is prepared for higher demand in their main geographical segments including many
emerging markets.
Excellence in Emissions Standards
As mentioned in the “Management Overview” section, Cummins experienced an emissions cover-up
scandal in 1998. Since that time, Cummins has turned around to become an industry leader in adhering
to and supporting future emissions initiatives. So much so that it has become a competitive advantage
to Cummins.
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 is selling their proprietary emissions solutions for use on their competitor’s engines, such as
Volvo and Navistar. Although stricter regulations do bring with them more costs, Cummins is uniquely
positioned.
Cummins innovation in the field is unparalleled. It was the first to receive certification for following the
EPA’s 2014 GHG standard for heavy-duty diesel trucks. This certification was due in part to the immense
amount of technology surrounding Cummins’ heavy-duty engine. It is equipped with an XPI high-
pressure common-rail fuel system, Variable Geometry Turbocharger, and an aftertreatment system with
a diesel particulate filter and selective catalytic reduction. Cummins engines all adhere to the current
standards, the most recent certification coming this past June from the California Air Resources Board
stating that Cummins 6.7L turbodiesel met Low-Emission Vehicle III standards.
In the case of stricter regulations, Cummins would benefit in that they are already ahead of the curve.
They are large enough that they could bear the cost to improve their engines quickly in the market, as
they have proven in the past. Cummins also benefits from being a components seller in that they can
also sell their superior emissions solutions in the event of a tightening in regulations. Many of their
competitors have a direct reliance on Cummins for their technology.

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Two-thousand fourteen was an important year for Cummins. It was the first year in which they rolled
out their new sustainability objectives. These objectives detailed reduction in GHG emissions by 25%
(from 2005 levels) by 2015, reduction in water waste by 33%, and achieving a 95% internal recycling rate
(from a current rate of 83%). This program demonstrates Cummins commitment to the environment
beyond just the technology they put into their engines.
This past October, Cummins opened their Seymour Technical Center for high-horsepower engines. This
plant in Columbus, Indiana focuses on developing technology for their engines in the 500 to 5,100
horsepower range. As Ed Pence, Vice President and General Manager of the high-horsepower engine
business, says, “With our laser-focus on meeting the needs of our customers, this technical center is a
tremendous advantage in our quest to always be better, faster, and first. This addition enhances our
Seymour site, which is now truly an industry-leading facility for engine design, testing, and
manufacturing with world-class credentials.” Along with this technical center, 12 new test cells have
been installed at the Seymour plant, where they can measure fuel efficiency, engine endurance, and
near-zero emission. The Seymour technical is just one small example of Cummins’ overall commitment
to maintain cutting-edge innovation.
Geographic and Product Diversity
Cummins has a unique global growth strategy. The company penetrates new markets through joint
ventures. If the venture is successful Cummins deploys more and more capital and usually ends up
acquiring its partner. This strategy is very effective because it reduces integration costs after the merger
is over. The distribution segment was able to grow at a rate of over 20% mainly due to successful
acquisitions in foreign markets. In order to minimize costs of international expansion, the company
mainly employs local employees. In China, out of the 9000 employees Cummins employs only 40 are
expatriates.
<<https://www.pwc.com/us/en/ceo-survey-us/2014/assets/tom-linebarger.pdf>>
While some companies in the trucking
industry had difficulties in 2014,
Cummins recorded its best year in its
history, despite a decline in
commercial truck sales. The gains
were accomplished despite a
significant decline in both heavy- and
medium-duty truck sales. Cummins’
success is attributed the ongoing
global strategy of diversification into
other engine markets, such as power
generation and marine.
As part of its growth strategy,
Cummins invests in businesses in
several countries that carry high levels risks such as China, Brazil, India, Mexico, Russia, and countries in
the Middle East and Africa. At the same time, the geographic diversity and broad product and service
offerings have helped limit the impact from a drop in demand in any one industry or the economy of any
single country on the consolidated results.
Although Cummins has investments in many markets all around the world, it has little exposure to
currency risks because it focuses on reinvesting the cash in the market where it was generated. The total

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of cash, cash equivalents and marketable securities held by foreign subsidiaries was $1.4 billion in 2014,
the vast majority of which was located in the U.K., China, Singapore, Belgium and India. The geographic
location of the cash and marketable securities aligns well with Cummins’ growth strategy. Cummins
manages cash requirements considering available funds among its many subsidiaries through which it
conducts business and the cost effectiveness with which those funds can be accessed. As a result,
Cummins does not anticipate any local liquidity restrictions to preclude the company from funding its
targeted expansion or operating needs with local resources.
If Cummins was to distribute its foreign cash balances to the U.S. or to other foreign subsidiaries, the
company would be required to accrue and pay U.S. taxes. For example, Cummins would be required to
accrue and pay additional U.S. taxes if it repatriated cash from certain foreign subsidiaries whose
earnings it has asserted are permanently reinvested outside of the U.S. At present, Cummins does not
foresee a need to repatriate any earnings from these
subsidiaries for which it has asserted permanent
reinvestment.
International expansion helps Cummins to benefit
from lower production costs from countries such as
China, India and Brazil, where Cummins manufacture
engines, generators and components for the local
market, and have developed excellent local
suppliers. Cummins’ efforts have resulted in
significantly reducing the cost of purchased
materials and services during the last six years.
International expansion also helped Cummins to
reduce its R&D costs. The company is performing
significant analysis work at its technical center in
India.
Cummins was also able to negotiate favorable cost-sharing arrangements with OEM customers and joint
venture partnerships worldwide. These initiatives helped Cummins to continue to be a technology
leader, while maintaining its research and engineering expense at approximately 3 percent of
consolidated net sales.
The Power Generation segment is focusing on attaining leadership positions in all major commercial
generator set markets globally, including growth in market share in European, Middle Eastern and
African markets and penetration gains in power electronics and controls, such as automatic transfer
switches and switchgear.
The Distribution segment is growing through the expansion of the aftermarket parts and service
business by capitalizing on its global customer base and fast growth markets in China, India and Russia
as well as the Middle East.
Shareholder Friendly
It is hard to ignore the movements Cummins makes to continue to enhance value for their shareholders.
Cummins has not decreased its dividend since February of 2008, when it was $0.125 per share. As of July
2015, this dividend was $0.975 per share. Recently, Cummins was named by MarketWatch as one of the
top ten dividend stocks. This, coupled with their 1 billion dollar stock buyback program, signals their
strong commitment to shareholders.

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Currently, Cummins’ dividend yield
is close to 4%. This is very strong in
today’s low interest rate
environment. The question arises,
though, if Cummins can maintain
this dividend in the coming years.
Compared to 2014 and 2015,
Cummins’ planned capital
expenditures are very low. This
implies that management is
satisfied with their position in the
current market and they have the
capacity to meet future demand
for quite some time. With cash in years to come not being tied up in capital expenditures, it is likely that
Cummins can maintain their current dividend levels. Of course, if the next cyclical downtown is
equivalent to the one experienced in 2008, it is more likely that they will have to cut down on dividends.
Dividends as a percentage of assets for Cummins reached 3.2% by the end of 2014, and they are on pace
to distribute dividends equal to 3.9% of assets for 2015.

Also, on November 10th
, 2015, Cummins approved a 1 billion dollar stock buyback program. This
program will start following the conclusion of their last 1 billion buyback program, initiated in July of
2014. Tom Linebarger stated at the announcement of the buyback, “By making good strategic choices,
adjusting our cost structure and quickly and operating our business well during periods of weak
demand, we will position Cummins for stronger performance when markets improve, as we have
demonstrated in prior cycles.” Cummins stock buyback programs display their commitment to return
value to shareholders even in times of economic downturn.

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Risks

We recognize 6 major risks to Cummins continuous growth of its business. There are many more risks
embedded in manufacturing businesses and systematic risks that companies are not able to diversify
against. However, in our opinion, the five most impactful risks to Cummins financial performance would
be: inability to utilize synergies from recent acquisitions; failure to adjust in timely manner to the
government regulations; insourcing by truck and OEMs manufacturers of the work currently done by
Cummins; vulnerability from single-source strategy; and increasing pressure from global competitors.
Inability to utilize synergies from recent acquisitions
Ability 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 United
States and Canada is very important to incorporate all possible cost savings to be more competitive.
Focusing especially on key employee retention, consolidation of expenses, eliminating redundancies, as
well as integrating all technology. Furthermore, delays in implementations of the acquisition plans may
adversely affect CMI operations in many outlooks: short, medium, and long term. Additionally,
Cummins is exposed to government approvals that may or may not be granted. Finally, a very important
occurrence in the acquisition process was the departure of key management staff (during some
takeovers); without those people, the company is losing a part of its potential competitive advantage.
Failure to adjust in timely manner to government regulations
As a manufacturer, CMI has to comply with very stringent and quickly-changing government regulations
in every country it operates. This aspect is extremely important to the engine segment, which is the
main revenue driver and is most exposed to regulations. As mentioned in our analysis, CMI is already
prepared with engines that comply with regulations that are to be implemented in 2016, however every
delay 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 to
design new engines in order to fulfill next regulations that should be effective in 2020. This additional
cost may affect financial performance because Cummins would be forced to increase R&D expenses.
Those expenses are inevitable, however, an additional wrinkle is the size of CMI, which can make the
implementation more complicated. For example, the preparation of different designs for different
markets.
Vulnerability to supply shortages because of
single-source supplier strategy
Since over 55% of total types of parts were single sourced in 2014, CMI
is very exposed to supply shortages. Even though established
partnerships are with credible, long-standing suppliers this situation
exposes company to idle time that would effectively bring a financial
loss. In the situation where one supplier will be unable to fulfill its
commitment finding the new one might take few weeks or even
months. This risk is real, and in our opinion, many analysts diminish it
strategic impact.

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Insourcing by truck and OEMs manufacturers
Most big CMI customers including Volvo, PACCAR, Navistar and Chrysler have their own engine
manufacturing capabilities and despite that they have chosen to outsource production of certain
engines to Cummins. Due to changing macroeconomic outlook or different corporate strategy this may
change in the future. Outflow of those customers would greatly affect the revenue stream as well as
cost structure, because many plants may become underutilized.
Increasing pressure from global competitors
As mentioned in the earlier point, many of Cummins’ clients are also its competitors. Such a situation
creates constant pressure on lowering selling prices as well as increasing product quality. Many
companies that buy from Cummins have the capabilities to compete with its engine branch that may
lead to decision to cease cooperation with CMI and beginning of the in-house production.
Furthermore, other engine producers compete with the company for contracts with OEM producers
which creates a constant struggle to cut costs without decreasing quality.

Holt Lens

The current stock price would make sense only if Cummins’ CFROI would drop drastically to a level
below its discount
rate. This is
unrealistic because
Cummins has been
constantly been
delivering value to its
shareholders.
Moreover, Cummins is
a mature and
diversified company and for that reason it is unlikely that the CFROI will drop so much in the next 5
years.

According to Credit Suisse Holt, Cummins is likely to outperform for two main reasons: improved
operating margins and
strong asset turns:
Cummins has been
constantly improving its
operating margins since
2003. That can be
attributed to better
management and to a
transitioning towards
products with higher

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margins.
Asset turns have been
very stable for Cummins.
This proves that Cummins
managed assets and
inventories efficiently.
Cummins asset turns are
15% better than
Caterpillar’s (their largest
competitor).
Even assuming a huge decrease in CFROI the company seems to be undervalued by at least 15%.
Although this drop is unrealistic, it just proves that the downside by investing in Cummins is extremely
limited.

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
Discount Rate 4.78 3.92 3.75 3.66

Cummins Pitch Final

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