CUMMINS INC annual report, FY2014

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Business context and reporting period

Cummins Inc. filed this Form 10-K for the fiscal year ended December 31, 2014. The company designs, manufactures, distributes and services diesel and natural-gas engines, engine components and power-generation systems through four segments: Engine, Distribution, Components and Power Generation. The filing also reports fourth-quarter results separately.

Financial performance

  • Full-year revenue: $19.221 billion, up 11% from $17.301 billion in 2013.
  • Profit: Net income attributable to Cummins was $1.651 billion, up 11%; diluted EPS was $9.02, up 14%. Operating income was $2.365 billion, up 13%.
  • Margins: Gross margin was $4.861 billion, or 25.3% of sales, compared with $4.280 billion, or 24.7%, in 2013. Higher volumes, distributor consolidation, lower material costs and favorable mix contributed; currency movements partly offset gains.
  • Cash flow and investment: Operating cash flow was $2.266 billion, versus $2.089 billion in 2013. Capital expenditures were $743 million. Cash and cash equivalents declined to $2.301 billion from $2.699 billion.
  • Liquidity: Cash, cash equivalents and marketable securities totaled $2.394 billion. Working capital was $5.034 billion and the current ratio was 2.25. Cummins reported $1.726 billion available under its revolving facility and $261 million available under other short-term facilities.
  • Debt: Total debt was approximately $1.7 billion; debt to total capital was 17.3%, down from 18.1%. The revolving-credit leverage ratio was 0.6x against a maximum of 3.25x. The company reported compliance with its debt covenants.
  • Shareholder returns: Cummins repurchased $670 million of stock and paid $512 million in dividends during 2014. The quarterly dividend increased from $0.625 to $0.78 per share beginning in the third quarter.

Fourth-quarter results

Fourth-quarter 2014 sales were $5.090 billion, compared with $4.588 billion in fourth-quarter 2013. Net income attributable to Cummins was $444 million versus $432 million; diluted EPS was $2.44 versus $2.32.

Segment performance

  • Engine: Segment sales of $10.962 billion rose 9%; EBIT increased 18% to $1.225 billion. North American on-highway demand improved.
  • Distribution: Sales of $5.174 billion rose 38%, largely reflecting acquired North American distributors. EBIT increased 27% to $491 million, including a $73 million acquisition-related remeasurement gain; EBIT margin fell to 9.5% from 10.3%.
  • Components: Sales of $5.118 billion rose 18%; EBIT increased 30% to $684 million, with margin improving to 13.4% from 12.1%.
  • Power Generation: Sales of $2.896 billion fell 4%; EBIT declined 23% to $168 million, and margin fell to 5.8% from 7.2%.

Material changes versus 2013

  • Growth was driven mainly by stronger North American on-highway demand and the consolidation of North American distributors. U.S. and Canadian revenue increased 20%; international revenue was flat, and foreign currency movements reduced sales by approximately 1%.
  • Gross margin improved, but selling, general and administrative expenses rose 15% to $2.095 billion. The effective tax rate increased to 28.7% from 25.1%, partly because 2013 included one-time tax benefits.
  • Operating cash flow increased, while cash declined amid acquisitions, capital spending, dividends, stock repurchases and foreign-exchange effects. Investing cash outflow rose to $1.234 billion, including $436 million of acquisitions net of cash acquired.
  • Power Generation weakened and recorded costs associated with actions to reduce its cost base. International on-highway shipments also declined, despite stronger North American truck demand.

Outlook, commentary and risks

  • 2015 outlook: Management expected North American heavy- and medium-duty on-highway markets to grow, the China ISG engine to gain share, and distributor acquisitions to increase Distribution revenue. It expected weak power-generation markets, continued weakness in Brazil and China, possible weakness in Europe, foreign-currency pressure, lower oil-and-gas demand and potential deterioration in mining markets.
  • Management planned $750 million to $850 million of 2015 capital expenditures and $170 million to $210 million for North American distributor acquisitions and related debt retirements. Expected 2015 pension contributions were approximately $175 million.
  • Management forecast a 2015 effective tax rate of 29.5%, excluding discrete items; it indicated the rate could be about 28.5% if the research tax credit were reinstated.
  • Unusual items: Power Generation recorded $32 million of fourth-quarter restructuring and other costs, primarily related to a German plant closure, with approximately 250 employees affected. Acquisition-related remeasurement gains were $73 million in 2014. Other income included a $73 million gain on fair-value adjustments for a consolidated investee.
  • Key risks: Cyclical markets and economic weakness; emission-rule timing and compliance costs; customer concentration and possible changes in engine outsourcing; product quality, warranty or recall exposure; reliance on joint ventures and other investees; single-source suppliers (about 55% of direct-material types); currency, commodity and interest-rate volatility; pension assumptions; tax uncertainty; and acquisition integration risks. PACCAR represented approximately 14% of 2014 sales. Cummins said it had no significant backlog.
  • The company reported pending ordinary-course lawsuits and environmental matters, stating that it did not believe the lawsuits were material individually or in aggregate, while cautioning that outcomes could still adversely affect results. It also identified itself as a potentially responsible party at fewer than 20 U.S. waste sites and expected aggregate remediation costs to be insignificant.

Important facts for investors to verify

  • How much of 2014 revenue and earnings growth reflects underlying demand versus distributor acquisitions and the $73 million acquisition-related gain.
  • Whether North American truck demand, China’s new ISG engine and distributor integration meet management’s expectations, and whether weak end markets or currency movements offset growth.
  • Whether the lower Power Generation performance and restructuring actions lead to a sustained improvement in segment margins.
  • The cash requirements and returns associated with planned acquisitions, capital expenditures, dividends, buybacks and pension funding.
  • Exposure to PACCAR and other major customers, single-source suppliers, equity-method investees, product warranty claims and unresolved tax or legal matters.