Recent Buy: Cummins Inc

Apr 17, 2015: Bought 19 shares of CMI at $134.62 per share.

Founded in 1919 and headquartered in Columbus, Indiana, CMI (NYSE:CMI) is one of the leading designers and manufacturers of diesel engines. The company also produces natural gas engines and engine components and subsystems. CMI sells its products to original equipment manufacturers, distributors, and other customers worldwide. 

CMI is ranked 4^th in the April 2015 edition of my 10 Dividend Growth Stocks article series. It also is the Industrials sector winner. The company has a 9-year streak of consecutive dividend increases. It pays quarterly dividends of 78¢ per share in the months of March, June, September and December.

My buy price results in an initial yield on cost (YoC) of 2.32%, which is below the 2.5% level I like to see. However, CMI is growing its dividend at an impressive, accelerating rate:

CMI Dividend Growth Rate
1 Year	3 Year	5 Year	10 Year
33.7%	29.1%	27.5%	14.5%

If dividend raises continue like that, my YoC will quickly surpass the 2.5% level! Here is a 5-year chart of CMI's dividend yield – the vertical jumps correspond to dividend increases:

Source: Dividend.com

In the following 10-year price chart, my buy price is indicated. Notice CMI's extraordinary performance relative to the S&P 500 over this period. The stock has outperformed the S&P 500 by a margin of 6-to-1. Of course, CMI's performance over the last year has been less than stellar.

Source: Scottrade

An investment in CMI 10 years ago would have returned a spectacular 796%, including dividends. That equates to a compound annualized growth rate of 25%! Not shown in the total return calculator below is the impact of dividend increases on YoC, which, after 10 years of dividend increases, would now be about 26%! 

Source: GuruFocus
It is highly unlikely that CMI would deliver similar results over the next 10 years. Nevertheless, I think the stock could deliver above-average dividend growth for many more years to come, even if earnings growth should slow down.

Analysis of CMI

My fair value estimate of CMI is $146.16, so I bought shares at a discount of about 9%. The following table provides some key statistics, with highlighted values relating directly to my selection criteria.


CMI passes the following of my selection criteria:

• A streak of at least 5 years of dividend increases (9 years)
• Chowder rule: Dividend yield plus 5-year CAGR exceeds 8% (34.33%)
• Earnings per share (EPS) percentage payout is less than 40% (34.59%)
• Debt to equity ratio is below 50% (22%)
• Price to earnings ratio (P/E) is less than 20 (TTM 15.14x and Forward 12.15x)
• P/E to annual EPS growth (PEG) ratio is less than 2 (1.10)
• 5-year CAGR is at least 10% (32.04%)
• Reasonable confidence in continued dividend growth (Yes)
• Price discount is at least 5% of fair value estimate (8.57%)

CMI fails the following of my selection criteria:

• Dividend yield exceeds 2.50% (2.32%)

Based on these statistics, CMI earns 6 out of a possible 7 stars: (******-)

(In the past week, since ranking a selection of stocks for my Seeking Alpha article 10 Dividend Growth Stocks for April 2015, CMI's star rating improved from 5 to 6 stars).

The following chart shows CMI's dividend payments and EPS over the last 10 years. Earnings growth is solid and it is evident that the company's growing dividend is sufficiently covered:


In fact, over the last 10 years, CMI's dividend payout ratio has not exceeded 33%, a level that is well below the 40% stated in my selection criteria.

Other ratings for CMI

MorningStar Rating  (***--)  S&P Capital IQ's Stock Report  (*****) Strong Buy   The Motley Fool's CAPS Rating   (*****)  Thomson Reuters StockReport+  (9/10) Positive  Zacks Rank (Style Scores*)  3-Hold (A•B•F)

*(Growth • Value • Momentum)

Concluding Remarks

CMI has treaded water for a while now, providing an opportunity to buy shares at a discount to fair value. It should be noted, though, that a quality company like CMI does not get discounted without reasons.  

The company operates in a cyclical environment. The North American truck cycle may be peaking, while emerging markets continue to struggle. Falling commodity prices and the strong dollar are compounding factors. CMI is experiencing a challenging situation in Brazil, where 2015 truck production is expected to decline 15% as the government curbed its financing program. 

CMI is looking to China for growth, but a slowdown in manufacturing and construction looks probable, which would impact truck and engine sales and, consequently, CMI's growth prospects.

Several analysis recently downgraded CMI, including Stifel and Goldman, citing reasons such declining Class 8 equipment orders and lower than anticipated market share in the Class 8 market, as well as the increasingly challenging multi-year outlook for machinery demand in Asia, the Middle East, and South America.

Nevertheless, I like CMI for several reasons. As a dividend growth investor, the company's dividend growth rate is very attractive and, given the relative low payout ratio, I expect strong dividend growth to continue in the foreseeable future. Aside from dividend payout increases, the company is also pursuing aggressive share repurchases. In 2014, for example, CMI repurchased 4.8 million shares for $670 million at an average price of $139.58 per share. 

For 2015, CMI expects revenues to increase 2-4%, with EBIT (earnings before taxes and interest) of up to 14% (which would top 2014's EBIT of 13.2%).

Finally, CMI is trading at a discount of about 9% to my fair value estimate of $146.16. A recent ModernGraham valuation of CMI rates the company as undervalued, while Baird upgraded CMI to Outperform with a price target of $166. 

19 shares of CMI adds $59.28 to DivGro's projected annual dividend income. I've updated my portfolio to reflect this purchase.

What do you think of CMI?