Investment Note Writing

Copal Amba

BUY Cummins incorporationTraining exercise only. Please see important notice on page 10

Strong 4Q2011 result, indicates growth

Analyst Name(94) 11 235 [email protected]

Price (@ xx Nov 2008)US$106.47

12-mth price targetUS$307.19

12-month High/LowUS$79.53 to US$129.51

S&P 5001353.39

Market cap $20325Estimated free floatx.x%Avg daily vol (US$m)US$x.xm

Issued ord sharesXxxmMajor shareholdersXyz (28%)Xyz (17%)

Latest results4Q 2011Next resultsFY – 2012

BloombergCMI

Performance data (%)1m 3m 12m

S&P 500 -1 0 2XXX.US -5 -13 -5Relative -4 -13 -7

A favourable market condition and a strong financial data of 2011 indicate the better growth of the company. Company has reported a record sale of $4.9milllion in the 4Q, 2011 which is 19% more from the same quarter of previous year. The growth has mainly driven from the higher demand in truck construction, power generation and oil & gas market in North America and we expect even a better growth in these segment in the near future as

The North American on highway truck markets expected to remain strong which is the largest market for the company.

India’s power generation markets are expected to improve and truck orders are expected to remain strong.

Brazil is expected to continue experiencing growth in the power generation business and is anticipating growth in after treatment business as the result of 2012 emission change.

Components sales in Brazil are expected to increase following the implementation of Euro V emission regulation.

Management has very high confident on the performance of the company in the near future and has set its target of $30milion revenue by the end of 2015.

We expect the sales will grow by 10% with an effective contribution from the emerging market like North America, India and china. Meanwhile, company has reported an EPS of 2.91 in 4Q 2011 and also has presented a ROCE of 44.3% in year 2011.the stock is currently trading at $106 which is far below of our target price of $307.

Table 1: Summary financials & valuation statistics

Year to 31 Dec 2010 2011 2012E 2013E

Revenue (US$m) 13226 18048 19744 21567

EBITDA (US$m) 1944 3048 3189 3634

Reported net profit (US$m) 1890 1912 2179 2537

Recurrent EPS (US$) 9.73 10.02 11.42 13.30

YoY change (%) 80.85 2.98 13.97 16.46

PER (recurrent) (x) 19.8 10.9 10.6 9.3

P/CFPS (x) 24.88 32.18 34.10 742.85

Yield (%) 3.8 3.8 7.1 0.4

ROE (%) 31 44.3 37.8 34.8

Source: Text Comes Here

Cummins, all set to beat the competition: we believe With the change in emission policy in many countries and the increasing demand of diesel engine and infrastructure in emerging market like India, China and North America, can lead to the better growth of the company, as

THIS REPORT HAS BEEN COMPILED AS A TRAINING EXERCISE ONLY. PLEASE SEE IMPORTANT NOTICE ON PAGE 10 1

Copal AmbaCummins is all set to introduce new standard engine (EPA14) and also has shown a 53% growth in North America market.

Sales volume and profit margin is to rise as the market has started recovering: The North American market (which is the largest market for the Cummins) has started showing a positive trend. Apart from it Emerging market like china and India are also expected to increase by 7-8% annually which gives us a fare look of increase in sales of the company.

Fair valuation with positive outlook: overall we see the current valuation is fare, as the market is recovering and the demand is increasing ,we believe the company will grow with an annual growth rate of around 10% which makes its valuation multiple is 7x,which is fare .

THIS REPORT HAS BEEN COMPILED AS A TRAINING EXERCISE ONLY. PLEASE SEE IMPORTANT NOTICE ON PAGE 10 2

TRAINING ASSIGNMENT Copal Amba

Cummins all set to beat the competition

SubheadingMarket leader in Emission Engine manufacturer

Cummins is a market leader in emission engine manufacturing industry. It mainly operates in four major segment Engine, power generation, components and distribution. But most of its revenue comes from engine segment (around 50%).it is the only company which is having its entire range of truck on Emission standard.

Increase focus on emerging market

Currently Cummins has an operation in more than 190 countries with a large distribution channel of 6500 dealer and 600 owned companies. The company has its major operation in North America(36%)and wanted its presence in Other emerging market like China and India which is expected to grow by 7-8%.The other market like Latin America, Canada, Africa/Middle east are contribution 12%,5% and 3% respectively in the revenue.

Positive effect of Emission control policy

Many countries have changed its emission control strategy and have set a new standard. Cummins is the only company which is having its entire truck engine on Emission standard. It also has followed the new standard of EPA14 engine.

Figure 1: Geographic division of salesSales in 2011Source: 2011k report

3

(3%)

Object 2


4

Object 2Geographic sales shows the maximum contribution from US (40%) and the minimum is from Canada (3%)


Sales volume and profit margin is to rise as the market has started recovering

The market has started showing positive trend and the demand has started booming as the result, sales in the North American market has shown a 53% growth in the 4Q, 2011 and expected to show even a strong growth in the future. The emerging markets like India and china has also shown a growth in demand and expected to grow by 7-8% in the near future. We expect the demand for the Cummins will increase in the future as many countries have tightened its emission control policy and Cummins is the only company which is having its entire engine on emission standard.

A new emission standard and the increasing demand of infrastructure and diesel engine in emerging markets encourage the company to set its sales target of $30million by 2018

5

Figure 1: EBIT margin comparision

2012E 2013E 2014E0.0%

4.0%

8.0%

12.0%

16.0%

Net margin

CMI Series2 Series3 CMI CATEMR

Year

Source: Amba research


6

Figure 2: Net Margin comparision

2012E 2013E 2014E0%

20%40%60%80%

100%120%

ROE

CMI Series2 Series3 CMI CATEMR

Year


Figure 3: ROE comparision

23.2

425

.23

28.4

827

.97

27.5

330

.26

30.0

935

.39

46.5

961

.82

67.6

163

.25

50.6

147

.40

72.8

666

.45

32.6

126

.51

20.4

033

.38

34.9

045

.80

45.6

146

.53

60.7

871

.35

74.4

082

.89

91.3

210

8.02

103.

7710

5.85

104.

8881

.66

95.7

1

-

20

40

60

80

100

120

140

160 Historical PE band chart

5.00 8.00 12.00 14.00

US$



Fair valuation with positive outlook

BUY, with a DCF-based target price of US$307, implying 189% upsideWe initiate coverage on CMI with a BUY rating and a target price of US$307, implying 189% upside. We used the discounted cash flow (DCF) methodology, and assume a WACC of 9.68% (beta of 1.4, ERP of 5%, RFR of 3.5%) and a terminal growth rate of 0%. Cummins is trading at price to equity (P/E) of 10.9. We believe the company should trade in line with its median peer P/E of 11.9x, given its positive growth aspects, increasing emerging markets, effective cost cutting, supply chain management and business development measures and a healthy balance sheet, with a target annual FCF of USD1.4bn. Our target price is also supported by better PEG of 1x. The stock jumped upwards following the third quarter results.

7

DCF firm value 60,384

Less net debt / add net cash 630

Deduct: MI 98

DCF equity value 59,656

Number of diluted shares (m) 194

DCF value per share ($) 307.19

Assumptions for calculation of WACC (%):

Symbol Assumption

Risk Free Rate of Return Rf 3.5%

Long Term Cost of Debt Kd 4.5%

Equity Risk Premium Rp 5.0%

Beta B 1.4

Tax Rate t 27.1%

Target Debt to Total Capital Wd 11.4%

Target Equity to Total Capital We 88.6%

Cost of Equity Ke 10.5%

WACC Dr 9.7%

Source: AMBA research


Figure 2: PE band chart

23.2

425

.63

25.5

926

.34

28.9

429

.30

33.0

330

.48

28.5

233

.21

36.9

946

.59

58.9

455

.29

67.8

458

.05

42.8

349

.34

54.1

669

.80

69.8

759

.46

32.6

124

.57

26.3

219

.48

27.2

436

.23

39.7

744

.49

50.2

142

.92

49.0

460

.78

69.3

665

.68

77.6

081

.02

94.4

910

4.25

109.

6197

.55

117.

7595

.87

104.

8894

.17

99.4

386

.83

113.

31

-

20

40

60

80

100

120

140

160

Historical PE band chart

5.00 8.00 12.00 14.00 20.00 Adj EPSAdj closing price 5.00 8.00 12.00 14.00 20.00

US$

We have done sensitivity analysis of Cummins share price based on our assumptions and using EV/EBITDA and DCF methodologies. Assuming the stock trades at a 0-3% terminal growth and 9.5%-11.5% WACC, it should trade in the USD272.13-345.09 range. We have also done sensitivity analysis for changes in the target exit multiple and WACC.

8

Table-5:Geographic Division of sales

307.19 10.5% 11.0% 11.5% 12.0% 12.5%

0.0% 289.79 280.56 272.13 264.41 257.30

Terminal Growth 0.5%

301.01 290.81 281.53 273.06 265.30

1.0% 313.41 302.08 291.82 282.50 273.99

2.0% 342.58 328.37 315.66 304.21 293.86

3.0% 379.53 361.24 345.09 330.74 317.90



Key determ

kKey DeterminantsPrice targetWe derived the price target on the basis discounted cash flow (DCF) as well as relative valuation method using EV/EBITDA and P/E multiples.

Catalyst to share price reaching price targetPositive sentiment about the company in the market for the future growth for emission standard engine and shifting trend in segment would act as a catalyst to share reaching price target.

.

Risks to recommendation and price target The stiff competition from the peers and the unfavourable market condition than expected

can put our recommendation on risk.

9

Table-6:Exit Multiple Sensitivity Analysis

WACC

307.19 10.5% 11.0% 11.5% 12.0% 12.5%

5.0x 289.79 280.56 272.13 264.41 257.30

Target exit Multiple 6.0x

289.79 280.56 272.13 264.41 257.30

7.0x 289.79 280.56 272.13 264.41 257.30

8.0x 289.79 280.56 272.13 264.41 257.30

9.0x 289.79 280.56 272.13 264.41 257.30


IMPORTANT NOTICE

The Report (“Report”) is a result of the training exercise carried out by all trainees of Copal Partners (UK) Limited (“Copal Amba” along with its affiliates and subsidiaries) and has been sent to you as a sample purely for the purpose of evaluating the work of Copal Amba. It does not in any way constitute investment advice and should not be construed as an offer to sell, a solicitation to buy, or an endorsement or recommendation of any company or security. Copal Amba does not guarantee the accuracy, completeness or other characteristics of the data/information of the Report.

The information in this Report (“Information”) has been compiled or arrived at from sources believed to be reliable and in good faith, but no representation or warranty, express or implied, is made as to their accuracy, completeness or correctness. Copal Amba has not verified the factual accuracy, assumptions, calculations or completeness of the Information. Accordingly Copal Amba accepts no liability whatsoever for any direct or consequential loss or damage arising from: (I) the use of this Report, (ii) reliance on any Information contained herein, (iii) any error, omission or inaccuracy in any such Information, or (IV) any action resulting there from. You are advised to verify the factual accuracy, assumptions, calculations, or completeness of the Information.

This Report may not be reproduced (in whole or in part), distributed or otherwise passed on to any other person without the express prior authorisation of Copal Amba.

Copal Amba (or related persons and/or affiliates) may have positions in or options on the securities mentioned in this Communication or in any related investments or may buy, sell or offer to buy or sell such securities or any related investments as principal or agent.

Copal Amba and/or any of its clients, officers, directors or employees may have effected transactions for their own account in the securities mentioned in this Communication or any related investments or have positions in associated or related companies prior to the receipt of instructions in relation to this Communication.

This Report may be sent to you by Electronic Mail of which transmission cannot be guaranteed to be secure or error-free as information could be intercepted, corrupted, lost, destroyed, arrive late or incomplete, or contain viruses. Copal Amba therefore does not accept liability for any errors or omissions in the contents of this message which arise as a result of e-mail transmission. If verification is required, please request a hard-copy version.

© 2015 Copal Amba

10

Documents

Investment Note Writing