Cummins - A Fair Value Report

This report is about Cummins, Inc. (CMI) and covers the company’s fiscal year ended December 31, 2020. Listed earnings and metrics utilizing earnings are for that specific 12 month time period unless otherwise noted. Unaudited or reviewed financial information is not a part of, nor included in, this report.

Wire, Copper, Electric, Stop, Closeup, Metal, Recycling

Image Source: Pixabay


What They Do

Cummins designs manufacture distributes and services diesel and natural gas engines and engine-related component products, including filtration, after treatment, turbochargers, fuel systems, controls systems, air handling systems and electric power generation systems. Listed competitors include Navistar International (NYSE: NAV) and Caterpillar Inc. (NYSE: CAT).


Short-Term Target

My current short-term target for the stock is $258.94 with an initial trailing stop set at $246.35. Based on a recent price of $250.10, the upward price movement will find resistance at $260.83 and again at $270.95, with final resistance found at $276.06. Downward price movement will find support at $245.46 and again at $240.24, with final support found at $231.40.


One-Year Growth Price Target

My one-year growth price target is actually a price target range, determined by adding year over a year earning growth to the prior year's annual dividend yield and dividing the result by the current annual price to earnings ratio.

For this stock, my current one-year growth price target range is $242-$286.


Volatility Adjustment

There are different metrics available to help investors determine the volatility of a particular stock as compared to the volatility of the market as a whole. To me, the beta ratio is the metric that is the most representative of a stock’s volatility. A beta ratio of less than 1 means that the security’s price will be less volatile than the market, while a beta ratio greater than 1 indicates that the security’s price will be more volatile than the market.

Basis my current beta ratio for this stock of 1.08, my volatility adjustment to recent pricing is $19 per share, making my current volatility adjusted price $232.


Quality of Earnings

A company’s earnings can be impacted by a variety of sources unrelated to the company’s current day-to-day operations. Discontinued operations, tax refunds, depreciation, and impairment, for example, may distort a company’s operating income and consequently its fair value. Investors should always explore the sources of a company’s operating income to better understand potential valuation impacts.

Of the company’s $15.83 per share in fiscal 2020 pre-tax income, $1.14 per share came from some combination of other sources, income taxes, interest, minority interests, or discontinued operations.


Key Performance Indicator Rating

I use key performance indicators (KPIs) as a barometer to measure the effectiveness of management. Several of the metrics that I use are the tangible asset ratio, return on invested capital, free cash flow growth, earnings growth, debt growth, the dividend payout ratio, and the cash conversion cycle. Admittedly, my use of these and other metrics as a way to determine the effectiveness of management is subjective. Based on a 0-105 scale, my KPI for this company is 44.


Annual Shareholder Return

I calculate annual shareholder return by subtracting the stock price at the close of business on the last day of a company’s fiscal year, from the stock price at the start of business on the first day of the company’s fiscal year, plus any dividends paid during that period and then dividing the result by the opening stock price on the first day of a company’s fiscal year.

For fiscal 2020, the company spent $4.34 per share buying back company stock, paid a common stock dividend of $5.30 per share, and had a year-over-year annual price appreciation of $47.94, which created a year-over-year annual shareholder return of 30%.

Over the prior five year period, the company spent an average of $5.64 per share buying back company stock, paid an average annual common stock dividend of $4.29 per share, and had an average annual price appreciation of $7.00, which created an average annual shareholder return of 14%. The company has paid a dividend for the past 36 years.


Cost of Common Equity

The cost of common equity is the minimum annual rate of return an investor should expect to earn when investing in shares of a particular company. I calculate this by adding the thirty-year Treasury yield to the beta ratio for the stock multiplied by my default equity risk premium.

My cost of common equity for this stock is 5.40%.


Weighted Average Cost of Capital

There is little in this world that does not come with some form of cost. Capital, which I define as cash used by a company for productive purposes and includes equity, debt, preferred stock, and dividends, is no exception. The weighted average cost of capital then, in simple terms, is the average cost the company pays for the necessary capital to operate its business and is proportionate to equity, debt, preferred stock, and dividends.

My weighted average cost of capital for this company is 2.84%.


The Year-Over-Year Numbers

There are many year-over-year numbers for investors to focus on. But to me, there are only a handful that have any significant meaning, and so those are the numbers that I highlight in this space. Please remember these are year-over-year numbers.

For fiscal 2020, revenue decreased 16%, earnings decreased 34%, free cash flow decreased 24%, and debt increased 76%. Additionally, the company’s annual operating rate, which I calculate by adding operating expenses to the cost of goods sold and dividing the result by net sales, was 90.


Current Price Ratios

Investing requires effort. Value investing requires patience. Stock prices require consideration. As a way to screen a company to determine if it is worth my effort, patience, and consideration, I use several price comparison ratios.

With a recent price of $250.10, the current Price to Earnings Ratio is 32, the Price to Book Ratio is 4, the Price to Tangible Book Value is 5, the Price to Debt Ratio is 9, and the Price to Free Cash Flow Ratio is 67. The company’s Return on Invested Capital is 9%.


Risk/Reward Ratio

I determine my risk-reward ratio by subtracting my current terminate target from a recent price and then dividing that result by my initiate target less a price fluctuation variable of 20%. What I am looking for with this ratio is a value of 5 or greater. My risk/reward ratio for this stock is 3.


Prior Five Year Averages

My average valuation for the prior five-year fiscal period was $183. The stock price during that time period averaged $143, earnings averaged $8.38 per share, and the average PE Ratio was 17.


Fair Value Investing

It is important to remember that the current market price of an equity is the price negotiated between a willing buyer and a willing seller. This market price is not the fair value of the associated company, but the negotiated price of a single equity trade.

The basic investing tenet for a fair value investor is price determines return. As such it is important to have some understanding of the value of the company as an ongoing concern and to develop a strategy that, with the current value in mind, will allow investment in that company at some reasonable discount to the current pricing.

My most recent fair value estimate for the stock of this company as an ongoing concern is $211. This estimated fair value forms the basis for my target prices as shown on my worksheet.

Cummins, Inc. (NYSE: CMI) – FYE 12/2020 – Fairly Valued – The stock is currently trading at levels above my most recent $148 initiate target, but below my most recent $264 reduce target. (Please See Linked PDF Worksheet.)

Financial statement data was obtained from the company’s most recent Annual Report on ...

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Comments

Krypto King 3 years ago Member's comment

Good read, thanks.