Autos

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

Don't mind the drop in Fiat supplier Cummins Inc. today. Things are actually looking up for the truck-engine maker. 

The stock plunged as much as 4.7 percent on Thursday after the Environmental Protection Agency accused Fiat Chrysler Automobiles NV of installing software on 104,000 diesel vehicles that ran afoul of pollution laws. Cummins does supply engines for Fiat Chrysler vehicles, but it doesn't make the ones that run the 2014 to 2016 Jeep Grand Cherokee and Dodge Ram 1500 pickups facing scrutiny.  So traders' knee-jerk reaction turned out to be unwarranted. 

False Alarm
Cummins shares initially plunged on news of the EPA's allegations against Fiat Chrysler, before recouping some of their losses
Source: Bloomberg

Cummins shares pared some of their declines after the company issued a statement clarifying its involvement in the Fiat situation. Yet the stock was still down about 1.5 percent at the close of trading in New York. Bad news for a major customer -- particularly when it can result in billions of dollars of fines -- is probably not great for business; other Fiat suppliers including Magna International Inc. and Adient Plc were also down. The reality is that given the Volkswagen AG emissions scandal and President-Elect Donald Trump's propensity for attacking automakers on Twitter, many a company in the industry may find themselves embroiled in bad headlines or lawsuits, valid or not.

While Cummins has had its own share of emissions-related headaches already, the significance of those pale in comparison to the allegations leveled at Fiat and certainly the pollution-law violations that will wind up costing Volkswagen more than $20 billion. Cummins was named alongside the U.S. unit of Fiat in a November lawsuit alleging the companies conspired to hide shortcomings in Dodge Ram 2500 and 3500 trucks that increased emissions and reduced fuel efficiency. But there's little to substantiate such claims of deliberate deception. Cummins has already taken charges to fix issues with the pollutant-treatment systems of certain vehicles, even though it didn't actually make the problematic part.

If there was a concern about Cummins lately, it was that the stock seemed to be getting ahead of itself after surging 60 percent over the past year. But now, that's starting to look somewhat justified, emphasis on somewhat. Investors have been betting for a while now that things are going to get better for Cummins, even as the company cut guidance, gave gloomy outlooks and data marched the wrong way. At long last, there are actually reasons to be optimistic.

Revved Up
Cummins has traded above analysts' average price target for the bulk of the past year. The majority of analysts now rate the stock a "hold," though at least two have recently upgraded their outlook to "buy"
Source: Bloomberg

A stabilization in energy prices looks to be in reach -- assuming OPEC actually follows through on its promised supply cuts -- and that could eventually revive demand for Cummins mining equipment. The company is starting to see improvement in China and market-share losses appear to be stemmed, or even poised to reverse. Meanwhile, Trump's plans for a massive infrastructure investment would boost orders at home for the company's heavy-duty trucks. Cummins should also benefit from corporate tax reform. 

A Ways to Go
Cummins' isn't expected to generate revenue growth until 2018
Source: Bloomberg

This doesn't mean Cummins's stock is primed for another huge surge. It's hard to see how it climbs meaningfully from here after trading above analysts' estimates so consistently and for so long. Notably, those analysts haven't meaningfully changed their revenue or earnings estimates for 2017 and 2018. At the very least, its stock price doesn't look quite so ridiculous.

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