China is giving Cummins a big boost, but will it last?


Greg AndrewsChina these days is giving a huge lift to diesel-engine maker Cummins Inc., which is one reason the Columbus, Indiana-based company has seen its shares surge 22 percent over the past year.

Company officials acknowledge they’ve been surprised by just how robust the Chinese market has been. In the third quarter, the company’s revenue in China, including joint ventures, was $1.2 billion, up 46 percent from the same period a year earlier. Cummins overall saw revenue jump 26 percent in the quarter, to $5.3 billion.

Company officials credit the surge in China to a range of factors, including robust infrastructure investment in the country and strong demand for trucks, fueled partly by new regulations imposed last year to limit overloading.

Cummins’ resounding success in China, while great news today, set a high bar for the company to attempt to top in future quarters, analysts acknowledge. BMO Capital Markets’ Joel Tiss said in a report that “if Chinese growth moderates to a more normal pace” and the company faces setbacks on other fronts, shares could drift down from current levels—around $167—to $150.

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On an Oct. 31 conference call with analysts, Cummins CEO Tom Linebarger appeared to temper Wall Street’s expectations for continued blockbuster Chinese growth.

“Some markets like China feel pretty—like they might be getting near the top” of the economic cycle, he said.

Cummins has known its way around China for a long time. J. Irwin Miller, the legendary former chairman of Cummins, visited China in search of business opportunities in 1975, years ahead of most executives. The company opened its first office, in Beijing, in 1979—a move that allowed it to build early relationships with JV partners that have lasted decades.

The country’s growth lately actually pales compared to the spectacular rates it racked up for decades. In 2016, GDP grew 6.7 percent, the slowest in 26 years.

The International Monetary Fund and some other forecasters predict it will continue to grow in the 6 percent range through 2021. But more pessimistic observers project GDP growth falling steadily in the coming years. Morningstar analyst Daniel Rohr, for instance, said in an October report that it might fall to 3.5 percent by 2021 as “easy” sources of productivity gains—such as urbanization and favorable demographics—dry up.

Bearish prognosticators also seize on the country’s aggressive use of debt to stoke growth. China’s debt now tops 260 percent of GDP, up from 162 percent in 2008.

“One way or another, deleveraging is a necessary condition for future growth,” Michael Pettis, a professor of finance at Peking University in Beijing, wrote on Bloomberg View in late November.

To be sure, even if Cummins hits a speed bump in China, the country will remain an enticing market for the company’s engines, components and power-generation equipment. The company’s products are used in a variety of applications beyond trucks and buses, including mining and construction.

Yet a slowing Chinese market would up the pressure on Cummins to keep other parts of its business humming—from the established North American market, which racked up a 25 percent revenue gain in the third quarter, to the emerging market of India, where sales also were strong.

Cummins’ shares have nearly doubled since mid-2015—despite some setbacks, including higher-than-expected warranty costs that have spurred quality-control concerns, and recent investor angst over whether the company is well positioned to capitalize on what one analyst called “the paradigm shift toward electrification.”

If all goes according to plan, Cummins will offer its first all-electric motors in 2019—first for buses and delivery vehicles, then for semis and other long-haul vehicles. Company officials believe their traditional diesel and natural gas power plants will stay in demand for decades. Even so, Cummins wants to make sure it offers the newest alternatives—and stays ahead of competitors that are doing the same.

“Although Cummins is widely viewed as a global technology leader, the evolution occurring in the industry is a significant leap that seems outside its core competency,” BMO’s Tiss said in a report.

Tiss added that “while the opportunity for electrification will likely be sizable, the competitive landscape is growing more intense.”•

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