12 March 2014 Update | Sector: Capital Goods

Cummins India
BSE Sensex 21,856 S&P CNX 6,517

CMP: INR515

TP: INR560

Buy

Early cycle play for investment climate uptick

LHP Products / Recon are important growth levers
Stock Info Bloomberg Equity Shares (m) 52-Week Range (INR) 1, 6, 12 Rel. Per (%) M.Cap. (INR b) M.Cap. (USD b) KKC IN 277.2 530/365 8/18/-10 142.4 2.3

Channel checks suggest initial pick-up in pre-buying decisions

Our channel checks suggest that dealers have started formally informing the customers about CPCB-2 implementation (wef June 2014) and also possibility of ~15%+ price increases. We understand that the conversion of inquiries into firm orders has been encouraging (with dealers reporting ~25-50% success rate across regions), and thus the dispatches are likely to pick-up post elections in May 2014. Recent excise duty cut of 200bps has also supported the buying decision. The interactions also suggest that the inventory in the chain remains at ~1-1.5 months, which is quite manageable in our opinion.

Financial Snapshot (INR Million) Y/E March 2014E 2015E 2016E Net Sales 41,289 45,836 54,222 EBITDA Adj PAT EPS (INR) Growth (%) BV/Share ( ) RoE (%) RoCE (%) P/E (x) P/BV (x) 7,182 8,066 9,977 6,078 6,938 8,547 21.9 -8 93 24.5 26.5 23.4 5.5 25.0 14 101 25.8 27.3 20.5 5.1 30.8 23 113 28.8 30.8 16.7 4.5

Tata Cummins commissions LHP plant; important logistics advantage

Tata Cummins has commissioned L / B Series engine manufacturing plant at Phaltan in Feb 2014, and would support the KKCs LHP genset plant commissioned in June 2013. This is an important logistical advantage as engine accounts for ~50% of the cost of a genset. Increased production at Phaltan will also lead to both direct and indirect tax benefits.

KKC is an early to mid cycle play for an uptick in the investment climate
A key challenge in India is the slow pace of project execution, with projects completed (as a % of projects under implementation) at abysmally low levels of 3.4%. This is largely given demand contraction in several industries, leading to projects being stuck in implementation stage. We believe that the initial round of demand improvement in several industries will be catered to by fast tracking these slow moving / stuck projects. KKC will be amongst the early to mid cycle beneficiaries to any investment cycle recovery as DG set is typically ordered at the fag-end of the project completion; and thus fast tracking of stuck projects could lead to a pent up demand in the system.

Shareholding pattern (% As on Dec-13 Sep-13 Dec-12 Promoter Dom. Inst Foreign Others 51.0 18.2 17.2 13.5 51.0 19.8 15.8 13.4 51.0 21.7 13.2 14.2

Stock Performance (1-year)

LHP Products / Recon are important growth levers, Maintain Buy

Over the last 18 months, KKC has seeded several growth levers, including: i) LHP Products, for Exports (potential revenues of INR10b+, vs INR3.9b in FY13) and Domestic (targeting ~15-20% market share, possible revenues of INR5b+) ii) Reconditioning (Recon), as CPCB-2 implementation will improve economic viability. We model revenue CAGR of 14.6% during FY14-16 largely led by potential ramp-up in LHP products and Recon business; excluding these segments, the growth CAGR stands at just 8.7%. Maintain Buy, with price target of INR560/sh (18x FY16E).

Satyam Agarwal (AgarwalS@MotilalOswal.com); +91 22 3982 5410 Nirav Vasa (Nirav.Vasa@MotilalOswal.com); +91 22 3982 5422
Investors are advised to refer through disclosures made at the end of the Research Report.

Cummins India

Channel checks suggest initial pick-up in pre-buying decisions

Channel checks suggest that dealers have commenced the process of formally informing the customers about the CPCB-2 implementation (wef June 2014) and also the possibility of a 15%+ price increase with electronic engines. We understand that the conversion of inquiries into firm orders has been encouraging (with dealers reporting ~25-50% success rate across regions), and thus the dispatches are likely to pick-up post elections in May 2014. Recent excise duty cut of 200bps has also supported the buying decision for the customers. The interactions also suggest that the inventory in the chain (including the factories) remains at ~1-1.5 months. KOEL in a recent investor concall has stated that for them, the inventory in the chain stands at ~1 month. This is quite manageable in our opinion. Given that the CPCB-2 implementation is now likely in June 2014, we believe that the production of CPCB-2 emission compliant engines will commence in May 2014, and dealers will attempt inventory restocking in May / June 2014.
Expect 13% CAGR in domestic powergen revenues led by LHP launch / CPCB price increase

Pre-buying should support domestic powergen sales in 4QFY14 (INR m)

Source: MOSL, Company

Source: MOSL, Company

Tata Cummins commissions LHP engine plant at Phaltan; important logistics advantage
LHP Engine Sourcing
Engine X Series S Series B Series Manufacturer Simpsons Tata Motors Tata Cummins

Tata Cummins has commissioned the L / B Series engine manufacturing plant at Phaltan in Feb 2014, and is the second engine manufacturing unit after Jamshedpur. The initial plant capacity stands at 15,000 L Series, and at full capacity can be ramped up to 45,000 units of L Series and 120,000 of B Series. This is very important from a logistics perspective, as KKC has also commissioned the LHP genset plant (in SEZ) in June 2013, where the initial capacity is 15,000 gensets pa, while current production stands at just 500 gensets per month. We believe that commissioning of the Tata Cummins plant will provide important logistical advantage, as engine accounts for ~50% of the cost of a genset. The SEZ tax incentives will continue for 15 years, and thus increased production will also lead to lowering of tax rates.

12 March 2014

Cummins India Phaltan: Eight manufacturing units have been commissioned till date
Domestic Tariff Area L / B series engines Upfit Centre for mid range engines (B5.9, 6.7 & 8.9) ReCon for low cost sales (Bring back worn out parts) HHP rebuild centre from 19 litres to 60 litres Parts Distribution Centre Special Economic Zone ReCon for low cost sales (Bring back worn out parts) Diesel engines for less than 200kva for exports HHP Facility Feb-14 Mar-13 2011 FY2012 Tata Cummins Tata Cummins CTIL KKC KKC

2011 CTIL CY2013 KKC CY2013 CTIL Source: Company, MOSL

KKC is an early to mid cycle play for an uptick in the investment climate
One of the key macro challenges in India is that the domestic investment cycle is currently being impacted by the next phase of the slowdown process, where the demand across end-user industries has been meaningfully curtailed. Projects completed (as a % of projects under implementation) have touched abysmally low levels of 3.4%, given the constrained economic viability and this has impacted the virtuous cycle of cash flow generation in the system. This is a key constraint as projects are stuck in implementation stage and the initial round of demand improvement in several industries will be catered to by fast tracking these slow moving / stuck projects. We increasingly believe that KKC will be amongst the early to mid cycle beneficiaries to any investment cycle recovery. In a project capex, DG set is typically ordered at the fag-end of the project completion; and thus fast tracking of stuck projects could lead to a pent up demand in the system.

Outstanding project investments (% YoY): Phases of investment cycle slowdown

Projects completed at abysmally low levels as economic viability remains poor, impacting cash generation cycle

Source: CMIE, MOSL

Source: CMIE, MOSL

12 March 2014

Cummins India

LHP products are an important growth driver

For LHP exports, the strategy is centered around new product launches and increased geography penetration, particularly in Africa, Middle East and LatAm. For Cummins Inc, these are also relatively new growth geographies and an important focus area. Also the product entails a different mindset in terms of marketing and servicing, coupled with the associated learning curve; thus entailing a gestation period for the inflexion point. An important part of the strategy is new product launches: in 2013, the Urja product range was extended by adding 140-175 kva range, and recently, the product range has been further extended to 330 kva. This, we believe, will provide a much bigger canvas in terms of global product positioning. Also, in 2013, gensets for the telecom market were launched; and orders have already been received from Africa. For LHP domestic, KKC is targeting 20% market share over the next 3 years. The CPCB-2 emission norms change provides opportunity to enter the business, given the increased technology play. The initial pilots in few states have been to largely understand the right channel for marketing and also the product offerings. Post these initial learnings, the nationwide launch is expected in the next 12 months. We model LHP revenues of INR9.5b in FY16 vs INR3.9b in FY13; and the growth rates are being led by traction in both exports (INR7.5b in FY16) and domestic (INR2b in FY16.

LHP sales stabilizing; next leg of growth to be led by geographical expansion / improving service network (INR M)
LHP HHP

12 March 2014

1QFY07 2QFY07 3QFY07 4QFY07 1QFY08 2QFY08 3QFY08 4QFY08 1QFY09 2QFY09 3QFY09 4QFY09 1QFY10 2QFY10 3QFY10 4QFY10 1QFY11 2QFY11 3QFY11 4QFY11 1QFY12 2QFY12 3QFY12 4QFY12 1QFY13 2QFY13 3QFY13 4QFY13 1QFY14 2QFY14 3QFY14

1,840 1,620 1,800 1,979 2,940 3,450 3,050 2,780 940 720 840 1,820 2,160 2,760 2,650 2,700 2,763 3,009 2,645 3,367 500 3,710 1,200 1,830 730 1,760 1,450 1,510 1,942 818 1,000 2,020 900 1,920

1,568 1,588 1,538 1,356

Source: Company, MOSL

Cummins India

KKC: Operational Matrix

FY09 Segmental Revenue (INR m) Power - MHP / HHP - LHP Industrial Auto Distribution - Spare Parts - Recon Domestic Exports - HH / HHP - MHP / LHP Net Sales (bef. eliminations) Eliminations Net Sales Growth (%) Existing Business % YoY New Businesses (LHP, Recon) % YoY Revenue Growth (%) Power - MHP / HHP - LHP Industrial Auto Distribution - Spare Parts - Recon Domestic Exports RM Costs (%) Contribution Margins (%) EBITDA margin (%) Net Working Capital (Days) Net Cash / (Debt), INR m FY10 FY11 FY12 FY13 FY14E 12,000 11,400 600 4,883 1,352 9,345 9,345 nm 28,350 12,056 7,556 4,500 40,405 0 40,405 -10.4 FY15E 13,440 12,190 1,250 5,371 1,554 10,466 9,716 750 31,602 13,261 7,761 5,500 44,863 0 44,863 11.0 FY16E 15,456 13,456 2,000 6,177 1,787 11,251 9,751 1,500 35,442 17,239 9,739 7,500 52,681 0 52,681 17.4

9,970 10,461 13,495 12,620 16,000 9,970 10,461 13,495 12,620 16,000 nm 3,550 4,400 5,588 5,360 5,140 1,060 2,600 2,600 2,490 1,590 7,590 8,860 10,116 7,620 8,900 7,590 8,860 10,116 7,620 8,900 nm 22,170 26,321 31,799 28,800 32,400 13,129 4,883 10,604 11,720 12,690 13,129 4,883 10,604 11,720 8,810 3,880 35,299 31,204 42,403 40,520 45,090 2,256 2,755 2,949 0 0 33,043 28,449 39,454 40,520 45,090 14.3 -13.9 38.7 2.7 11.3

33,043 28,449 39,454 40,520 41,210 35,305 37,363 41,681 14.3% -13.9% 38.7% 2.7% 1.7% -14.3% 5.8% 11.6% - 3,880 5,100 7,500 11,000 31.4% 47.1% 46.7%

-2.5 -2.5 0.7 -30.6 16.8 16.8 34.7 81.4 66.7% 33.3% 15.6% 71.3 3,803

4.9 4.9 23.9 145.3 16.7 16.7 18.7 -62.8 62.1% 37.9% 20.0% 54.2 7,528

29.0 29.0 27.0 0.0 14.2 14.2 20.8 117.2 63.8% 36.2% 18.9% 48.4 7,836

-6.5 -6.5 -4.1 -4.2 -24.7 -24.7 -9.4 10.5 64.3% 35.7% 16.9% 62.1 7,455

26.8 26.8 -4.1 -36.1 16.8 16.8 12.5 8.3 62.9% 37.1% 18.2% 65.5 9,289

-25.0 -28.8 -5.0 -15.0 5.0 5.0 -12.5 -5.0 61.3% 38.8% 17.4% 72.0 9,461

12.0 6.9 108.3 10.0 15.0 12.0 4.0 11.5 10.0 61.5% 38.5% 17.6%

15.0 10.4 60.0 15.0 15.0 7.5 0.4 100.0 12.2 30.0 62.0% 38.0% 18.3%

66.9 60.1 9,592 12,173

Source: Company, MOSL

12 March 2014

Cummins India

Financials and valuation

Income statement
Y/E March Net Sales Change (%) EBITDA EBITDA Margin (%) Depreciation EBIT Interest Other Income PBT Tax Tax Rate (%) Reported PAT Extraordinary items Adjusted PAT Change (%) 2011 40,425 40 7,635 18.9 366 7,268 48 804 8,025 2,114 26.3 5,911 0 5,911 33 2012 41,172 2 6,972 16.9 420 6,552 54 1,233 8,246 2,334 28.3 5,913 -514 5,501 -7 2013 45,894 11 8,349 18.2 473 7,877 46 2,067 10,514 2,872 27.3 7,641 -616 6,606 20 2014E 41,289 -10 7,182 17.4 520 6,662 40 1,750 8,372 2,294 27.4 6,078 0 6,078 -8

(INR Million)
2015E 45,836 11 8,066 17.6 650 7,416 60 1,958 9,313 2,375 25.5 6,938 0 6,938 14 2016E 54,222 18 9,977 18.4 750 9,227 60 2,079 11,247 2,699 24.0 8,547 0 8,547 23

Balance sheet
Y/E March Share Capital Reserves Net Worth Debt Deferred Tax Total Capital Employed Gross Fixed Assets Less: Acc Depreciation Net Fixed Assets Capital WIP Investments Current Assets Inventory Debtors Cash & Bank Loans & Adv, Others Curr Liabs & Provns Curr. Liabilities Provisions Net Current Assets Total Assets 2011 396 17,667 18,063 183 -187 18,058 9,144 4,734 4,411 0 7,255 16,804 5,190 7,182 1,037 3,396 10,411 7,109 3,302 6,393 18,058 2012 554 19,877 20,432 0 -70 20,362 9,703 5,054 4,649 497 5,976 19,826 5,676 6,783 2,235 5,132 10,585 6,849 3,736 9,241 20,362 2013 554 23,313 23,867 0 328 24,195 10,415 5,480 4,934 1,208 6,276 24,279 5,304 8,550 3,547 6,878 12,502 7,719 4,783 11,777 24,195 2014E 554 25,175 25,729 0 328 26,057 12,915 6,000 6,914 1,000 6,276 23,135 4,525 8,145 3,719 6,747 11,269 6,844 4,425 11,867 26,057

(INR Million)
2015E 2016E 554 554 27,410 30,769 27,965 31,323 0 0 328 328 28,293 31,651 15,415 16,415 6,650 7,400 8,764 9,014 1,000 1,000 6,276 6,276 24,599 29,551 5,023 5,942 9,293 10,399 3,850 6,431 6,434 6,778 12,347 14,190 7,598 8,991 4,749 5,199 12,252 15,361 28,293 31,651 E: MOSL Estimates

12 March 2014

Cummins India

Financials and valuation

Ratios
Y/E March Basic (INR) Adj. EPS Cash EPS Book Value DPS Valuation (x) Payout (incl. Div. Tax.) Valuation(x) P/E Cash P/E Price / Book Value EV/EBITDA Dividend Yield (%) Profitability Ratios (%) RoE RoCE Turnover Ratios (%) Asset Turnover (x) 2011 21.3 22.6 65.2 15.0 82.3 2012 19.8 22.8 73.7 11.0 59.8 2013 23.8 29.3 86.1 12.0 50.9 2014E 21.9 23.8 92.8 13.0 69.4 2015E 25.0 27.4 100.9 14.5 67.8 2016E 30.8 33.5 113.0 16.0 60.7

21.6 17.5 6.0 16.6 2.3

23.4 21.6 5.5 19.3 2.5

20.5 18.8 5.1 17.2 2.8

16.7 15.3 4.5 13.6 3.1

35.1 43.3

30.7 34.1

34.5 35.4

24.5 26.5

25.8 27.3

28.8 30.8

2.4

2.1

2.1

1.6

1.7

1.8

Cash flow statement

Y/E March OP/(Loss) before Tax Depreciation Interest Direct Taxes Paid (Inc)/Dec in Wkg Cap Extraordinary items (net) CF from Op. Activity (Inc)/Dec in FA & CWIP (Pur)/Sale of Invt Others CF from Inv. Activity Inc/(Dec) in Net Worth Inc / (Dec) in Debt Interest Paid Divd Paid (incl Tax) CF from Fin. Activity Inc/(Dec) in Cash Add: Opening Balance Closing Balance 2011 8,025 366 48 2,114 -1,253 0 5,072 -1,440 75 0 -1,366 1,389 96 48 4,666 -3,228 478 559 1,037 2012 7,732 420 54 2,334 -1,072 514 5,314 -2,082 1,652 0 -429 -225 -183 54 3,185 -3,647 1,237 1,037 2,275 2013 9,898 473 46 2,872 -1,509 616 6,651 -1,469 -340 0 -1,809 84 0 46 3,607 -3,570 1,273 2,275 3,547 2014E 8,372 520 40 2,294 300 0 6,938 -2,292 0 0 -2,292 0 0 40 4,434 -4,474 172 3,547 3,719

(INR Million)
2015E 2016E 9,313 11,247 650 750 60 60 2,375 2,699 -455 -747 0 0 7,194 8,611 -2,500 -1,000 0 0 0 0 -2,500 -1,000 0 0 0 0 60 60 4,503 4,969 -4,563 -5,029 131 2,581 3,719 3,850 3,850 6,432 E: MOSL Estimates

12 March 2014

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Cummins India

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