THE HEDGEYE EDGE
Shares of Cummins (CMI) are only about 17% from their 2018 all-time highs. It is a classic cyclical set-up – a low 9.5x multiple on a local peak in earnings luring investors in to a value trap. Even management thinks it’s a peak or near peak across their markets.
The potential for the electrification narrative and Traton/NAV to be a sizeable valuation headwind is substantial. The build rate has been over 3x preliminary July orders (the lowest since the GFC), rates have given up the electronic logging surge, and freight volumes are far from encouraging. Commodity prices and general industrial activity are also near-term headwinds.
We doubt there will be any prize for being early for a turn in shares of CMI and think it is a short that is playing out.
While we get the bull arguments for CMI, from aftermarket to emerging markets, we see too many business and narrative headwinds going into 2020. Cyclicals have a way of genuinely looking ‘cheap’ when they are in fact expensive; we think shares of CMI are pricier than longs believe.
We think the shares have >40% downside risk, with catalysts ranging from truck order backlog drawdowns to high decremental margins in key engine markets.
A deceleration in activity may adversely impact the profitability of suppliers to capital equipment makers. Added to short-term and long-term structural headwinds, as well as fewer emission-related content opportunities in CMI’s key North American market, the next couple of years may prove unusually challenging for CMI.
ONE-YEAR TRAILING CHART
