Autos

Brooke Sutherland is a Bloomberg Gadfly columnist covering deals. She previously wrote an M&A column for Bloomberg News.

Cummins Inc. investors are an optimistic bunch.

When we last checked in on the maker of truck engines in April, it was the best performing U.S. industrial company in the S&P 500, despite a less-than-stellar outlook. Since then, Cummins has lowered its revenue growth guidance and cut its forecast for this year's Ebit margin. On Monday, the company found itself embroiled in a lawsuit alleging that it had conspired with the U.S. unit of Fiat Chrysler Automobiles NV to hide shortcomings with engines on certain generations of Dodge Ram pickups that sometimes led to a near doubling of emissions and reduced fuel efficiency. Shareholders' reaction: is that the best you got?

What Goes Down, Must Come Up
By Tuesday, Cummins shares had already recovered their losses on the news of the emissions lawsuit
Source: Bloomberg
Intraday times are displayed in ET.

While Cummins shares fell immediately after each of those events, they've bounced back every time and have managed to climb another 19 percent from where they were trading back in April. On Tuesday, Cummins rose about 1.9 percent, more than making up for its decline the day before, and is now the second-best performer on the S&P 500 Industrials Index. (It was edged out of the top spot this week by infrastructure specialist Quanta Services Inc., which is spiking in a bet that Donald Trump will push ahead with a massive spending bill as president.)

Bigly
Cummins is among the best-returning stocks in the S&P 500 Industrial Index so far this year.
Source: Bloomberg

As regards the latest hiccup, it's worth noting that Cummins says the lawsuit has no merit and the company intends to vigorously defend itself. I'm no lawyer, but Barclays analyst Robert Wertheimer, for one, doesn't think the complaint will create a significant new liability. While the suit attempts to draw a connection to the emissions-cheating scandal that may wind up costing Volkswagen AG nearly $20 billion, there's no clear evidence that Cummins was attempting to be deceptive with its engines, Wertheimer says.

The owners of Dodge Ram pickups from 2007 to 2012 allege that pollutants weren't always fully broken down and were instead released. The U.S. Environmental Protection Agency and California Air Resources Board have called for a recall of newer models of the trucks, according to Reuters. Cummins had already taken a $99 million charge in the third quarter (on top of an existing $99 million in loss contingencies) after finding quality issues with pollutant-treatment systems in a certain population of vehicles. The problematic component in that instance wasn't made by Cummins, the company says.

This suggests that whatever damage might be caused from issues with Ram truck engines is already quantified and contained. In which case, Cummins shareholders are probably justified in shrugging off the lawsuit. But that doesn't explain how they've been able to be so sanguine about the other challenges facing the company.

Cummins also sells engines for off-highway equipment like mining tools and boats. That part of its business has been struggling amid the commodity price downturn of recent years and weak industrial growth. Meanwhile, an improved outlook in China isn't yet rosy enough to offset tepid demand North America for heavy-duty trucks. Analysts aren't forecasting a rebound in Cummins revenue until 2018, and even then, its total sales will be much closer to what the company generated in 2013 than last year. Margins are also shrinking and Cummins faces mounting questions over its ability to maintain market share. 

Rev Your Engines?
Cummins' sales outlook leaves much to be desired
Source: Bloomberg

Investors seem to be prioritizing other things right now. Cummins has a low debt load of less than 1 times its Ebitda, according to data compiled by Bloomberg, putting it well within the range that Bloomberg Intelligence found was optimal for auto suppliers. The same can't be said for auto suppliers American Axle & Manufacturing Holdings Inc. or Johnson Controls spin-off Adient Plc. On top of that, Cummins has returned $1.3 billion to shareholders so far this year through buybacks and dividends as part of a plan to pay out 75 percent of its cash flow. And it's not as expensive from a valuation standpoint as some others in the S&P 500 Industrial Index, including Illinois Tool Works Inc. and Acuity Brands Inc.

Shareholders are betting that they'll be able to ride the stock even higher as things (eventually) start getting better. But even if you believe that all of Cummins's challenges will work themselves out, there are a lot of potential speed bumps looming for a company priced for no speed bumps. Since February, Cummins has traded above analysts' average price target on all but about 30 days -- after staying consistently below their expectations in the previous four years.

Off to the Races
Cummins has traded above analysts' price target for most of the year
Source: Bloomberg

At some point, it'll take more than positive thinking to keep the rally going.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Brooke Sutherland in New York at bsutherland7@bloomberg.net

To contact the editor responsible for this story:
Beth Williams at bewilliams@bloomberg.net