For The Tribune
A strong resurgence in multiple markets fueled a revenue spike for Cummins Inc. and a record quarter for sales.
The Columbus-based global power company, best known for making diesel engines, Tuesday reported third-quarter revenues of nearly $5.3 billion, which represented a 26.2 percent increase from sales of nearly $4.2 billion reported in the third quarter of 2016.
Cummins’ third-quarter net income of $453 million, or $2.71 per diluted share, increased from $289 million, or $1.72 per diluted share, during the same period last year. That reflects a year-over-year increase of 56.7 percent in net income for the quarter.
Earnings before interest and taxes (EBIT) of $640 million increased from $398 million compared to a year ago, up 60.8 percent.
The last time Cummins had greater net income and EBIT was the second quarter of 2015, when the company reported net income of $471 million and EBIT of $721 million.
Cummins recorded this level of profitability despite incurring $92 million in charges related to quality problems.
Revenues were strong across multiple business sectors.
Sales in North America increased 25 percent due to higher demand in truck, oil and gas, and construction markets. International sales grew 28 percent primarily due to strong truck and construction demand in China, sales of new products in India and increased demand from global mining customers, the company said in a news release.
“Cummins experienced positive momentum in demand in a number of important markets, resulting in strong sales growth in the third quarter,” said Tom Linebarger, Chairman and CEO of the Fortune 200 company. “Earnings improved over the year-ago period due to stronger volumes and operational improvements that more than offset increased quality costs.”
As a result of the strong third quarter, Cummins has increased its full-year revenue growth forecast to 14 to 15 percent, up from its 9 to 11 percent projection stated when second-quarter results were released in August.
Cummins’ full-year revenue forecast has steadily increased this year.
The company announced in February, when 2016 fourth-quarter and year-end results were released, that it expected 2017 revenue to be flat to down 5 percent. When Cummins released first-quarter results in May, the company adjusted the projection to a 4 to 7 percent increase.
“We are experiencing strong movement in a number of markets and several lines of new products,” Linebarger said.
Segment sales jump
All four of the company’s four core business segments experienced significant sales increases in the third quarter.
Engine sales of more than $2.3 billion jumped by 25.7 percent from last year’s third quarter. On-highway revenues increased by 25 percent, and off-highway revenues increased 30 percent primarily due to increased demand globally in truck and construction markets, the company said.
The Distribution segment record sales of nearly $1.8 billion, representing a 16.6 percent increase. Organic sales increased 12 percent because of improved sales to off-highway markets, and acquisitions and the disposal of power generation rental assets in North America produced a net percent increase in revenues, the company said.
Power Systems sales of nearly $1.1 billion reflected a 23.4 percent increase. Increased demand for industrial engines from mining and oil and gas customers primarily fueled revenue growth, the company said.
The Components segment’s record sales of more than $1.5 billion represented an increase of 34.1 percent from last year. International revenue increased 45 percent, primarily due to higher truck demand in China and the sale of new products in India, and sales in North America increased 26 percent due to stronger orders from on-highway customers, the company said.
Impact of quality issues
Despite the news of Cummins’ strong quarter, its stock price dropped Tuesday to $176.88 (-1.92 percent), a day after closing at a then-record $180.35. Local Cummins analysts said the decline was related to ongoing problems with quality. National analysts zeroed in on the quality issues during an earnings call with Cummins leaders Tuesday morning.
A $63 million charge related to a powertrain safety campaign, and a $29 million charge was for an emissions problem, said Pat Ward, vice president and chief financial officer, during the earnings call.
The U.S. Environmental Protection Agency and the California Air Resources Board this year began selecting certain Cummins pre-2013 model year engine systems for additional emissions testing. Cummins was notified that a portion of the selected engine systems failed emissions testing due to the unexpected breakdown of an after-treatment component.
“We’re reviewing all aspects of product quality to see where improvements can be made, including outside specialists,” said Rich Freeland, Cummins president and chief operating officer.
Company leaders said they are developing and testing solutions to address technical issues related to the problems. The $29 million charge is the expected cost of field campaigns to repair some of these engine systems.
Cummins also is evaluating other engine systems for model years 2010 through 2015 that could potentially be subject to similar breakdown issues.
Quality issues have tempered earnings this year. Cummins also incurred about $57 million in product quality costs in the second quarter.
“We’re disappointed with the one-off issues that keep cropping up,” Linebarger said.
Analysts react
Local analysts said Cummins beat Wall Street’s expectations for the quarter despite the problems with quality.
Wall Street was looking for earnings per diluted share in the $2.47 to $2.57 range. Cummins delivered $2.71, but if the costs related to quality problems were extracted the true earnings per share were $3.01, said Scott DeDomenic, senior vice president and analyst with Hilliard Lyons in Columbus.
International and U.S. markets are providing growth for Cummins and the company expects to reach $20 billion in sales by year’s end, DeDomenic said.
However, that is tempered by the fact that Linebarger is promising certain profit margins that are falling short because of costs associated with quality problems, DeDomenic said.
“They could be looked at as growing pains,” said Craig Kessler, chief investment officer of Columbus-based Kessler Investment Group.
Cummins is responding to markets quickly, Kessler said. With new products and by expanding its portfolio for the future, the focus on revenue could be coming at the expense of quality control, he said.
Roger Lee, a senior research analyst with Columbus-based Kirr, Marbach & Co., echoed those thoughts, while also adding that the company executed well in taking advantage of improved market conditions.
“When you have a company growing that fast, it’s hard to keep an eye on everything,” Lee said.
Electrification footprint
The company has increased its footprint in the electrification field recently. Cummins and GILLIG announced an electrified power partnership Oct. 9. The collaboration involves integrating and optimizing new battery electric technology offered by Cummins to power GILLIG zero-emissions transit buses. Cummins announced Oct. 16 the purchase of Oregon-based Brammo Inc., an energy storage technology company, to help accelerate Cummins’ electrification platform. Brammo designs and develops battery packs for mobile and stationary applications.
And on Oct. 25 Cummins, Microsoft and McKinstry announced the opening of their new Advanced Energy Lab in Seattle. The lab’s purpose is to demonstrate independence from the traditional electrical grid by integrating fuel cells directly into the 20-rack data center.
“This isn’t your father’s Cummins anymore. This is a Cummins that is leading the charge into integration with other technologies,” Kessler said.
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“Cummins experienced positive momentum in demand in a number of important markets, resulting in strong sales growth in the third quarter. Earnings improved over the year-ago period due to stronger volumes and operational improvements that more than offset increased quality costs.”
— Cummins Chairman and CEO Tom Linebarger
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Cummins’ stock price closed at $176.88 Tuesday, down $3.47 (-1.92 percent) from its record close Monday of $180.35.
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