Cummins India Stock Falls On Concerns Over Draft Bill To Cut Diesel Genset Use

Shares of Cummins India Ltd. declined after India invited feedback to a proposed legislation aimed at providing round-the-clock power and reducing usage of polluting diesel generators.

Macquarie

• Maintains 'underperform' rating with a target price of Rs 620, implying a potential downside of 37.8%.

• The domestic powergen segment, which is about 30% of Cummins India's revenue, includes sales coming from mid-range, heavy duty and high horsepower categories. These categories cater to large establishments (shopping malls, commercial offices) and mission critical applications (hospitals, airports) which, in our view, will continue to install backup sets even if there is 24x7 power promise from the government.

• In our view, the only demand pullback could be seen in the low horsepower segment that accounts for a small 3-4% portion of the total topline as per our assessment based on historical data.

• In our view, the probability of such an event playing out is low because the alternative of battery storage for backup powergen is currently impractical for non-utility scale applications given the power density limitations of that system.

• The stock decline is probably a result of sentimental impact of this government document rather than its financial impact.

• In our view, the business impact on Cummins India will be limited from the proposed rules and it does not materially change the outlook for key segments of Cummins India and does not pose a risk to fundamental multiples.

• Our rating on Cummins India emanates from expensive valuation and the elusive, unconfirmed market-anticipated merger of Cummins India with the unlisted parent entity Cummins Technologies India.

Jefferies

• Maintains 'underperform' rating, with a target price of Rs 530, implying a potential downside of 46.5%

• The draft, if finalised, is a negative for the medium-term outlook of diesel gensets and Cummins.

Nomura

• Maintains ‘reduce’ rating with a target price of Rs 666, implying a potential downside of 27.4%.

• Draft electricity rules reinforce our view of structural challenges to diesel-based power; challenges emerge for diesel gensets and engines in back-up power and construction in addition to existing headwinds on railways.

• We expect headwinds for the distribution segment, while the longer term replacement of diesel gensets as a means of back-up power by consumers reduces the installed equipment base for Cummins India and thereby impacts demand for spares and services.

• Distribution is a relatively higher-EBITDA-margin business than the rest of Cummins India’s portfolio, and thus, its profitability can be impacted.

• The impact on powergen business from construction power demand can also be significant. Infrastructure accounted for 20% of Cummins India’s powergen sales in FY19. The combined effect on distribution and powergen can be significant if the draft legislation is enforced.

• Even in data centres, there is a conscious thrust to move away from diesel as a back-up power to the usage of battery technology, hydrogen fuel cells or even advanced data analytics tools like Microsoft Azure to implement the green data centre concept. While this may not be an immediate threat to Cummins India, the same can be a challenge in the long term.

• Key risks include stronger-than-estimated benefits from cost reduction initiatives, and stronger than expected domestic and exports demand.

Systematix

• It is best to avoid both Cummins India and Kirloskar Oil Engines for now.

• The draft rules pose a serious concern on the survival of diesel generating set manufacturers like Cummins India and Kirloskar Oil Engines even though we would argue that the rules are very aggressive and impractical to be implemented over the proposed time frame of five years.

• It poses a structural concern over the existing domestic business (50-80% of revenues) of the diesel genset manufacturers. Investors should keep away from these stocks until there is clarity on the final rules and/or alternate fuel technology capability from these players.

• Global players like Cummins India already have technology to counter this measure with hydrogen fuel-based gensets and battery empowered gensets working globally. However, these offerings are still niche and not core for Cummins India. It will be optimistic to expect Cummins India to be able to move its portfolio to offerings with battery backup as it is not the company’s core and will always be a trading business, offering very little value addition and margins.

• The best-case scenario is that the circular is withdrawn and not implemented for now. It's a concern over the longer term that the diesel genset business will gradually decline and not have a terminal value, making it structurally negative.

Kotak Institutional Equities

• Maintains ‘buy’ rating on the stock, with a fair value of Rs 1,080, implying a potential upside of 17.6%.

• Do not see the rationale of a big change in demand for diesel gensets in India on the promise of a more reliable supply of electricity. Nor do we see the case for a big shift to green fuels for gensets as a means to lower pollution levels in cities.

• The power generation data for Cummins Global suggests a healthy 12% growth over CY2014-19 for North America. This reflects the relevance of the diesel genset as an insurance against grid failure. While such need for insurance is mature in developed markets, it may still continue to grow within the Indian context.

• Large-scale applications may shift from diesel genset backup based on improved battery storage capabilities. Data centres would account for mid-to-high single-digit share of Cummins India’s revenues by FY2024.