Latin Manharlal Securities Pvt Ltd. 124 Viraj, S,V.Road, Khar (W), Mumbai S t o c k I d e a

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1 S t o c k I d e a Date: 08-Feb -13 CMP: `508 TARGET: `618 Upside: 21.7% B U Y SENSEX NIFTY 5904 Eq. Cap. (` Crs) Face Value (`) 2.0 M. Cap (` Crs) 14,082 BSE Code NSE Code Financial Year CUMMINSIND Apr-Mar 52-w H/L 550/396 Avg. Daily Vol TTM EPS (`) TTM P/E (x) 19.6x BVPS (`) P/BVPS (x) 5.38x Stock vs. Sensex Latin Manharlal Securities Pvt Ltd. 124 Viraj, S,V.Road, Khar (W), Mumbai CUMMINS INDIA LTD (Cummins India) Incorporated in 1962, Cummins India Ltd (Cummins India) is the India s leading manufacturer of Diesel and Natural gas engines for Power generation, Industrial, Automotive and Distribution markets. Part of the US$13.2 billion Cummins Inc., Cummins India is the largest company in Cummins Group in India. Presence across varied markets with strong customer base Industrial Business Unit (IBU) caters to almost the entire gamut of diesel engine requirement for the industrial sector. Power Generation Unit (PGU) is the leading manufacturer and market leader of diesel fuel power systems. The Automotive Business caters to the growing commercial vehicle segment in India with its range of engine platforms and related technologies alongside parts, services and components. The Distribution Business engaged in the business of sale of engines, and providing after-market support to customers in India, Nepal and Bhutan. Strong Opportunities exist for its all Business Units Next stage of emission norms is slated to come into effect in July 2013, and will provide an opportunity to introduce new, lower emissions diesel generator sets. Cummins India enjoys strong business relationships with the domestic as well as global construction equipment leaders and is well positioned to serve the needs of this segment. Emission regulations (CPCB II norms in year 2013 for generator sets) and migration to electronic engines is likely to improve the opportunities for the Distribution Business. Growing power shortage to demand positive for DG Sets Since India's energy needs were growing faster than its production capacity, power problems seemed to be here to stay in the country. The recurring power shortages, with an average and peak power deficit of ~7% and ~14% respectively, coupled with low quality power supplied by the SEBs in almost all the states meant that alternative power sources would inevitably be needed. Cummins India with a market share of over 35% stands to gain from the opportunity. Price hike on Gen-set engines to improve margins During Nov 2012, Cummins India has announced a price increase of up to 3% for its DG sets and generator set engines in the range of 7.5 kva and 3000 kva. The price increase was effective from January 01, This is the 2nd increase, with the earlier 3% made during Jun Cummins India engines carry a sticker price of Rs 1.5 lakh up to Rs 2 Crs per unit and it manufactures 55,000 60,000 units of a range of low end to high end power generation engines annually. We believe with the softening commodity prices and depreciation in INR have improved margin outlook for the company. Strong 3QFY13: Better than expected results Cummins India reported a better-than-expected revenue growth on the back of strong domestic revenues (up 21% Y-o-Y), led by power (up 50% Y-o-Y) and distribution segment (up 15%). Positive Guidance for FY13E & FY14E For FY13E, the management expects revenues to grow 10%. Domestic sales are expected to grow by 12-13% Y-o-Y (vs earlier expectations of 10-11%) and export sales to grow by 5-10% Y-o-Y (vs earlier expectations of 0-5%). At the CMP of `508, the stock is trading at 18.1x its FY14E EPS of ` We recommend BUY on the stock with a months target price of `618, providing an upside of 21.7% from the current levels. Please Refer DISCLAIMER on the Last Page

2 Company Profile India s leading manufacturer of Diesel and Natural gas engines for Power generation, Industrial, Automotive and Distribution markets Incorporated in 1962, Cummins India Ltd (Cummins India) is the India s leading manufacturer of Diesel and Natural gas engines for Power generation, Industrial, Automotive and Distribution markets. Part of the US$13.2 billion Cummins Inc., Cummins India is the largest company in Cummins Group in India. The company started off with a partnership between Kirloskar and Cummins in the year But, in late 1997, Kirloskar s sold their ownership; resulting in Cummins Inc. increasing its stake to 51%. Cummins in India is a group of 8 legal entities across 200 locations in India with a combined turnover of Rs.8500 Crs and employing close to 11,000 individuals. Business Model - operates in 4 business units Industrial Engine Business caters to the industrial sector with its broad spectrum of diesel engines ranging from 65 HP to 3500 HP. The range is designed to power varied market segments such as Construction, Mining, Compressor, Marine, Rail, Agriculture, Pumps, Oil & Gas, Power Generation and Defence. Power Generation Business addresses standby and prime power needs through the design and manufacture of pre-integrated generator sets (gensets), transfer switches, paralleling equipment and controls. Revenue Break-up:3QFY13 19% 5% 34% 28% 14% Power Generation Distribution Exports Industrials Automotive Automotive Business integrates Cummins diesel and natural gas engines with related technologies such as filtration, exhaust, turbo, fuel and coolant systems and lube oil to serve the commercial vehicle segment in India. Distribution Business operates under the brand name Cummins Sales and Service India. Acquired in 1967 with the objective of providing products, packages, services and solutions for uptime of Cummins equipments, it has since been engaged in sale of engines and providing after-market support to customers in India, Nepal and Bhutan. Cummins India Ltd Feb-2013

3 INVESTMENT POSITIVES Presence across varied markets with strong customer base Industrial Business Unit (IBU) caters to almost the entire gamut of diesel engine requirement for the industrial sector. IBU has the unique advantage of in-house facility to design value package systems for various applications. The high quality and inspection standards, Six Sigma, Kaizen, ERP processes, demonstrate its commitment to continuously deliver best-in-class products to all its customers. Important sectors for Cummins India are Infra, Manufacturing, Construction, IT/ITES, Realty, Retail, Hospitality, Textiles, Food Processing, Telecom and Pharma Power Generation Unit (PGU) is the leading manufacturer and market leader of diesel fuel power systems. It is a single window provider of complete power solutions offering top-of-the-line products (diesel and gas) and services. It also provides total power solutions, right from design to execution and operations to service support. Important sectors for Cummins India power generation solutions are Infrastructure, Manufacturing, Construction, IT/ITES, Realty, Retail, Hospitality, Textiles, Food Processing, Telecom and Pharma. The Automotive Business of Cummins India caters to the growing commercial vehicle segment in India with its range of engine platforms and related technologies alongside parts, services and components. Committed to producing the cleanest engines in the world, the company is a frontrunner in developing emission technology that promises a clean and safe environment. Clean, efficient, dependable and durable, diesel and natural gas engines are backed by genuine Cummins parts and a service network that spans the nation. The Distribution Business was formed with the objective of providing products, packages, services and solutions for uptime of Cummins equipments. It has since been engaged in the business of sale of engines, and providing after-market support to customers in India, Nepal and Bhutan. Over the years, the business has grown from strength to strength, and has successfully established itself as a 'Dependable' after-sales service support arm of Cummins. Strong Opportunities exist for its all Business Units Power Generation: Enjoys strong business relationships with the domestic as well as global construction equipment leaders Indian power sector continues to witness energy deficit. Thus the demandsupply gap will continue to spur the demand for captive power options. Industrial growth spurred by domestic demand is expected to continue thereby increasing demand for backup power from most sectors. Next stage of emission norms is slated to come into effect in July 2013, and will provide an opportunity to introduce new, lower emissions diesel generator sets. This is likely to change the competitive dynamics in the industry significantly. Industrial: Increase in budget allocated towards infrastructure and other measures announced will help in infrastructure development. Cummins India enjoys strong business relationships with the domestic as well as global construction equipment leaders and is well positioned to serve the needs of this segment. Cummins India Ltd Feb-2013

4 Increased budget outlay in Rail Budget with focus on safety, modernization and expansion indicates a rise in demand for engines for Diesel Electric Multiple Units (DEMU), Power Car and track maintenance machinery applications, thus creating additional opportunities for Cummins India. In the coming years, with the Govt s increased focus on oil and gas exploration and production, opportunities exist for Cummins India to explore demand for its engines in oil and gas exploration, production and distribution applications. Emission regulations (CPCB II norms in year 2013 for generator sets) and migration to electronic engines is likely to improve the opportunities Automotive: With expanding roadways, the market is moving towards higher tonnage commercial vehicles, where Cummins India occupies a strong market share. The company product range including both mechanical and electronic products is available for OEMs to meet their business and regulatory requirements. Distribution: Emission regulations (CPCB II norms in year 2013 for generator sets) and migration to electronic engines is likely to improve the opportunities for the Distribution Business. Increasing customer expectations and outsourcing trends are likely to drive demand for comprehensive maintenance contracts along with product purchases for industrial and mining sectors. Improved customer reach, enhanced network capabilities and continuous improvement of service delivery and quality remains the key to drive profitable growth through Customer Support Excellence. Committed to introduce new products + improve existing product lines With a view to satisfy customer and market needs, Cummins India is committed to introducing new products and improve existing products which will have better performance levels, lower life cycle costs and meet stringent emission norms. The Technical Center of Cummins India, in collaboration with the parent company - Cummins Inc., U.S.A., continues in its endeavour to indigenize components and develop the next generation of components and systems to reduce costs, improve fuel efficiency, enhance performance and durability of its products. In addition, to improve technical productivity, new methodologies and technologies have been introduced and enhancements in capabilities are being continuously pursued to reduce the costs associated with new product development and customer support. The Company has launched new products during FY12 which include: Emission recipe to meet BS-IV emission regulations for Automotive ratings. BS-III products to enhance competitiveness in the Automotive segment and drive towards lower fuel consumption and higher power density product offerings for customers. Multiple engine families to meet the upcoming CPCB II Power Generation regulations. Cummins India Ltd Feb-2013

5 Key Industrial engine product families to support the increasing Industrial Business. Fundamental electronics capability to help achieve upcoming OBD II (On Board Diagnostics) legislation. Enhancement of non-diesel product development capability. Improved capability in intake air characteristic measurements to enhance understanding and control of the combustion process. The management has guided that future plan of action for Cummins India will be: Developing local solutions to meet upcoming emission regulations and market needs. Technological innovation to add value to the products in the areas of alternate fuels and hybrid engines. Continued expansion of the product range to serve the local and global market needs. Providing energy efficient solutions to reduce carbon foot print. Continued focus on indigenization and partnering with suppliers for waste elimination initiatives. Alternate source development for various engine components. Low range engine development for Power Generation Market. DG Sets turned out to be the most popular choice for both industrial as well as domestic users Cummins India with a market share of over 35%, stands to gain from the opportunity With growing power shortage, demand for DG Sets is expected to be steady India suffers from an acute shortage of electricity and power, even after being the 4 th largest consumer of electricity and power in the world, following USA, China and Russia. The power shortages translated into massive power cuts and intermittent supply issues, which in turn affect all segments of the Indian economy. According to the International Energy Agency (IEA), India requires a further US $ 135 billion in investment for the power sector. With an installed capacity of ~2,07,006 MW, India is falling short to meet the demands of a rapidly growing economy and population. This excessive demand has put a strain on the power producers. At current, the Indian power sector comprising of ~66% from thermal, ~4% from nuclear, ~19% from hydro and ~11% from renewable and alternate sources. Since India's energy needs were growing faster than its production capacity, power problems seemed to be here to stay in the country. The recurring power shortages, with an average and peak power deficit of ~7% and ~14% respectively, coupled with low quality power supplied by the SEBs in almost all the states meant that alternative power sources would inevitably be needed. Thus, the dieselgen-sets (DG Sets) turned out to be the most popular choice for both industrial as well as domestic users as they were faster and easier to install and also economical to operate. We believe with growing power shortage, demand for DG sets is expected to be steady in next few years and Cummins India with a market share of over 35%, stands to gain from the opportunity. The use of DG sets is common in semi-urban and rural areas with long and frequent power outages and old and unreliable distribution networks. Cummins India Ltd Feb-2013

6 Indian DG Sets Market - is well organized + Highly competitive Total gen-set market is now estimated to grow steadily at a CAGR of about 10.1% in revenue terms between CY E The DG Sets market in India is a well organized and highly competitive market. The market for DG Sets in India can be broadly classified as small diesel generators (15-75 kva), medium diesel generators ( kva) and large diesel generators ( kVA). The market witnessed steady growth rates in the last decade on account of chronic power shortages and rapid growth across several segments such as industries, infrastructure, telecom and IT and ITES. The total gen-set market is now estimated to grow steadily at a CAGR of about 10.1% in revenue terms between CY E. High growth in the industrial sector and peak power deficit at ~14% is expected to boost DG Sets sales in India. The telecom sector was the key growth driver for the small DG Sets market in the recent past. The kva diesel generator set market witnessed a slight slowdown in the last years on account of saturation in certain telecom circles which necessitated several tower infrastructure firms to place their tower addition plans on hold. Price hike on Gen-set engines to improve margins During Nov 2012, the Power Generation Business of Cummins India has announced a price increase of up to 3% for its DG sets and generator set engines in the range of 7.5 kva and 3000 kva. The price increase was effective from January 01, This is the 2 nd increase, with the earlier 3% made during Jun The management has also stated that due to escalation in input costs such as steel, copper, lubricants, Cummins India is constrained to hike prices. Notably, the price increases are done in a period when cost pressures, particularly commodity prices, have moderated. We believe with the trends of softening commodity prices and depreciation in INR have improved margin outlook of Cummins India in the near term. Cummins India engines carry a sticker price of Rs 1.5 lakh up to Rs 2 Crs per unit and it manufactures 55,000 60,000 units of a range of low end to high end power generation engines annually. In FY12, power generation business alone had contributed ~Rs 1,500 Crs through sales in the domestic market and exports revenues had touched ~Rs 1,100 Crs. Manufacturing Units / Capacities Cummins India has 3 state-of-the-art plants at Pirangut and Daman in India. As part of its expansion, the company is setting up a new state-of-the-art facility at Cummins Megasite at Phaltan. Source: Company, LMSPL Research Cummins India Ltd Feb-2013

7 Expansion initiatives at the Megasite in Phaltan The Megasite constitutes almost 10 facilities in total, out of which 4 are operational Cummins India is well placed with its expansion initiatives at Megasite, Phaltan. It is 300 acre projects initiated by Cummins India at Phaltan Baramati Area, marking the beginning of a campus that will see nearly 10 facilities operating from one location in the coming few years. The project has been awarded by the Government of Maharashtra, is designed to house ongoing and future expansions of Cummins. The Megasite constitutes almost 10 facilities in total, out of which 4 are operational and remaining would be operational by CY2016E and contribute additional ~Rs.1500 Crs to the overall revenue. The company has also established the India Parts Distribution Center (IPDC) with an aim to enhance supply chain efficiency in aftermarket parts distribution. Equipped with state-of-the-art infrastructure, this Center will serve as a logistics hub to facilitate improve inbound receiving and inventory management capabilities and enhance Cummins India ability to serve its customers significantly. The IPDC has been in operation since the 3QFY12. B, C and L series engine upfit facility is expected to commence operations soon A facility for Power Generation Business Unit to manufacture generator sets and generator drive engines in the low and medium HP range for export markets (with a total installed capacity of 51,000 units by CY2016) is now expected to commence operation during mid CY2013E. This facility is being set up in the MIDC SEZ. The B, C and L series engine upfit facility is expected to commence operations soon. This facility will have an annual capacity of 20,000 engines and shall cater to the requirements of construction, compressor, marine and fire pump sectors. Strong 3QFY13: Better than expected results Cummins India reported a better-than-expected revenue growth on the back of strong domestic revenues (up 21% Y-o-Y), led by power (up 50% Y-o-Y) and distribution segment (up 15%). EBITDA margin expanded by 80 bps (Q-o-Q) and 280 bps (Y-o-Y) to 17.8% on the back of lower material cost as well as other cost along with better product mix. Other income was higher by 101% Y-o-Y and 152% Q-o-Q to Rs Crs spurred by dividend income from subsidiaries as well as profit on sale of property. Taxation in absolute terms was higher by 26% Q-o-Q and 41% Y-o-Y to Rs.75.5 Crs. Thus the growth at net profit stood higher by 66% Y-o-Y to Rs Crs. Cummins India Ltd Feb-2013

8 Positive Guidance for FY13E & FY14E For FY13E, the management expects revenues to grow 10%. Domestic sales are expected to grow by 12-13% Y-o-Y (vs earlier expectations of 10-11%) and export sales to grow by 5-10% Y-o-Y (vs earlier expectations of 0-5% Y-o-Y). For FY14E, domestic revenues are expected to grow 10-15% and exports growth likely at 5-7% Y-o-Y. Growth in domestic market in FY14E would largely be supported by price increase driven by CPCB norms (expected in 3QFY14E), while volumes are expected to be moderate. For FY14E, capex target is Rs.5-6 bn (including the office campus, etc). Management has indicated that the company is likely to monetize of some part of the real estate at Kothrud Under the new CPCB II norms, engines to cost 10-15% higher while gensets to cost 5-7% higher (upto 800 kva). We believe Cummins India is likely to be a key beneficiary of CPCB II norms, which is expected to provide a fillip to DG Sets pricing and profitability. Growth in exports would largely be supported by Low HP products, while High HP exports (~55% of total exports) are likely to show sluggish growth. Capex for FY13E is expected at Rs.2.3 bn (vs Rs.1.5 bn in FY12), and so far till 3QFY13 the company has spent ~Rs.1 bn. For FY14E, capex target is Rs.5-6 bn (including the office campus, etc). Management has indicated that the company is likely to monetize of some part of the real estate at Kothrud, post commissioning of the new office, and the realization could be ~Rs.2 bn. If monetized it will be used to meet the capex requirements. Though the diesel price hike might have a short-term impact on volumes, the company does not envisage a significant impact in the medium/long term. CONCERNS Slowdown in global economy impacts engineering sector Volatility in raw material prices such as steel, iron, etc Competition from domestic and international companies Cummins India Ltd Feb-2013

9 VALUATIONS At the CMP of `508, the stock is trading at 18.1x its FY14E EPS of ` We recommend BUY on the stock with a months target price of `618, providing an upside of 21.7% from the current levels. Profit & Loss A/c - ` Crs FY09 FY10 FY11 FY12 9MFY13 Net Sales Total Expenditure EBITDA Margin 14.4% 18.5% 18.9% 16.9% 17.4% Depreciation EBIT Interest Other Income PBT Tax Fringe Benefit tax Deferred Tax PAT Extraordinary Items Adjusted PAT Margin 12.7% 15.6% 14.6% 13.1% 17.0% EPS (`) Source: Company, Capitaline Registered Office: 124 Viraj, S,V.Road, Khar (W), Mumbai Tel. (022) , Fax (022) research@lmspl.com LMSPL Network: Fort, Mahalaxmi, Parel, Bandra, Santacruz, Vile Parle, Andheri, Malad, Kandivili, Borivali, Bhayender, Ghatkopar, Mulund, Chunabhatti, Jacob Circle, Masjid Bunder, Cotton Green, Thane, Bhiwandi, Panvel, Pune, Sholapur, Nasik, Malegoan, Ahmednagar, Aurangabad, Akola, Mahekar, Nagpur, Surat, Karjan(Baroda), Khambat, Ahmedabad, Rajkot, Surendranagar, Porbandar, Amreli, Bharuch, Anand, Chennai, Vishakhapatnam, Vizianagaram, Palasa, Kakinada, Karnal, Kolkatta, Bhubhaneshwar, Hyderabad, Bangalore, Jafrabad, Chital, Kodinar, Keshod, Gondal, Haryana, Srikakulam, Mehkar (Buldhana, Jamnagar, Bangalore, Jodhpur, Jalgaon, Malkangiri (Orissa), Karimnagar Dist. (Andhra Pradesh) This document is for information only and is meant for the use of the recipient & not for circulation. The information contained in this document has been taken from publicly available information, trade and statistical services & other sources. While the information contained herein is from sources believed to be reliable, we do not hold ourselves responsible for its completeness and accuracy. All opinions and estimates included in this report constitute our judgement as of this date and are subject to change without notice. Investors are expected to use the information contained in this report at their own risk. This report is not and should not be construed as an offer or the solicitation of an offer to buy or sell any securities. M/s Latin Manharlal Securities Pvt. Ltd. and its affiliates may act as market maker or have assumed an underwriting position in the secure-ties of companies discussed herein and may sell them to or buy them from customers on a principal basis. Cummins India Ltd Feb-2013