Some companies you listen to because their stocks themselves are good investments–and because of their insight into a big chunk of the economy and trends in the economy. For example, I pay attention to what Deere (DE) says in its quarterly earnings report because the farm equipment maker is a great company (shares of Deere are a member of my long-term 50 Stocks Portfolio) and because the company keeps its finger on the pulse of farm incomes and the health of the farm sector.
I follow Cummins (CMI) with a similar dual purpose. The diesel engine maker is, like Deere, a member of my long-term 50 Stocks Portfolio. And Cummins has also developed, over time and out of self-interest, a real skill in calling the turns in the business cycle. Much of the company’s success in recent decades has come from recognizing when a downturn is coming, cutting costs in anticipation of that downturn, and using those cost savings to keep investing in research and development so that the company comes out of the downturn with a pipeline full of new products and set to grab more market share from competitors.
So one of my reasons to check in with the February 6 conference call that followed Cummins’ report of fourth quarter earnings was to see where the company thinks we are in the business cycle. As a maker of engines that go into everything from Big Rig trucks to a new Dodge RAM pickup Cummins is positioned to observe first hand how a big piece of the U.S. economy is faring.
Let’s get the earnings and revenue numbers for Cummins out of the way. The company reported fourth quarter earnings of $3.48 a share, 16 cents a share on a GAAP basis worse than Wall Street had expected. Revenue climbed 11.9% year over year to $6.13 billion against the Wall Street forecast for $6.08 billion.
Most of the increase in revenue came from increased truck produce in North America and in global demand from the construction and power generation (Cummins sells diesel engines used as backup for cloud data centers, for instance.) Revenue took a 2% hit from the strong dollar. For the 2018 year Cummins’ sale were a record $23.8 billion, up 16% year over year. EBITDA margins (that’s earnings before interest, taxes, depreciation and amortization) were 14.6% against 14.8% in 2017.
So a very strong quarter and year–just not as strong as Wall Street wanted.
Which does lead to this question: Has Cummins seen the peak of the business cycle for this time around?
The company’s guidance for 2019 certainly points to that possibility. For 2019 Cummins expects revenue to be flat to up 4%.
Potential problems for 2019 include a slowdown in sales of the big Class 8 trucks that use Cummins engines. And lower demand for construction equipment from China–with sales of excavators falling 25% in 2019. Truck sales will fall 10% in China, the company projects. Sales of power systems in China should continue strong, however, with projected growth in that market of 29% for the full year.
When the company got around to talking timing of any slowdown in the conference call, company officials seemed to point to the second half of 2019 as a rough time line for any drop. Right now the company is projecting what it called “a bit of a reduction” in the second half of the year. Truck makers have seen some increase in cancellations recently, Cummins noted. That could still fill in, but while business is strong “maybe over the horizon looks like a downturn.” Which means that the company is taking steps now so that it can be ready when/if the downturn comes. Which includes, now, not spending capital the Cummins doesn’t have to spend.
As downturns go, this isn’t a forecast for dire times. But it is a projection that says that Cummins’ markets could well be slowing.
To go from that back to the company. On its record, I can’t think of a company that has more experience and better results at managing turns in the business cycle. So I have to say I’m not worried about Cummins from that perspective.
But this downturn won’t be taking place in normal times for Cummins. The company has to make a transition from a position as the dominant player in the diesel market to a world where more and more of the vehicles made by its customers will use transitional natural gas engines or fully electric engines. Cummins has developed new products for both those markets and has seen good early success. In the fourth quarter the company signed an important contract, for example, with a Chinese truck maker for electric engines. But it’s early in this transition and the challenge is by no means small for Cummins. Long-term investors should watch the company’s sales of electric engines very, very attentively for the rest of 2019.