Ockham Reseach - the Razor's Edge

Knock, Knock… Cummins

Looking through some of the pundit discussions, we saw that Jim Cramer was commenting on Cummins Incorporated (CMI) last night. Cramer quickly laid out some thoughts (as he normally does) stating that he thinks its a great company, but now would not be the time to buy the stock. It also has its ex-dividend date of today, so that ship has sailed as well. With a current dividend yield of about 3.24%, this was not an insignificant opportunity.

As with most “lightening round” discussions with Cramer, or any pundit, we have real concerns with “Sound Byte Investing” as we have come to call it at Ockham. It is fine to have a quick instinct, but the theories and stories espoused by Malcolm Gladwell in his bestselling book “Blink“, aren’t necessarily optimal for long term investing. In the coming months, we will examine this “twitter” like mentality as it is applied to investing and what the best way to benefit from the changing face of pundit advice to investors.

In this case, Cummins, Inc. has some very interesting business lines, but most are automobile related. Cummins designs, manufactures, distributes and services diesel and natural gas engines, electric power generation systems and engine-related component products, including filtration and exhaust aftertreatment, fuel systems, controls and air handling systems. Interestingly, CMI is also quite diversified globally with more than 51% of Cummins’ business coming from operations outside of the United States. As they have stated, their business model is to push further into China and India through strategic partnerships, which is a wise global plan.

Problem of course with all of this is, what will they do through a recession? And with the big 3 automakers begging for more money today on Capitol Hill, one must be very cautious with a company that relies so heavily on truck sales. The Dodge 2500/3500 truck line has been extremely popular, and with some very simple modifications is capable of running on alternative fuels.

As a value investment framework, Ockham Research is similar to a private equity firm in terms of our valuation methods. We are always on the lookout for value in the form of sales and cash numbers. In the case of CMI, Ockham views their current Cash Earnings as significantly below their historical average multiples of Cash Earnings, as calculated by our proprietary analysis. It is incredibly important to understand that for CMI, the current level of Cash Earnings compared to its historical levels helps identify where CMI is in relation to what the investing community was willing to pay for this level of Cash Earnings in the past.

Again, with the incredibly negative impact of recessionary spending cuts, CMI may be in a whole new ball game in terms of its historical numbers.

However, with a historical high Cash Earnings per share ratio of 9.54 and a historical low Cash Earnings per share ratio of 4.18, an investor can relate where value could become optimal.

When we talk about Price to Cash Earnings numbers for CMI we are looking specifically at CMI to see if the market is recognizing the huge disparity between CMI’s past stock price to Cash Earnings ratio to today’s levels. At a difference of 57% below the average historical Price to Cash Earnings ratio, our view would be quite positive at this point. However, as with all metrics, we need to also take other factors into account when looking at CMI (read Recession). While we view better Cash Earnings metrics as very important, if the market is slow to identify this value, or if Cash Earnings were to fall from these levels, we would become more neutral in our stance.

So bottom line? Ockham currently views Cummins as Undervalued. Now we know the doomsday folks will be quite angered by this, but we can’t help but think this is a company with great prospects for the future. No matter how you slice it, trucks make money, and if you really think we are headed for a depression, I suggest you buy a Cummins truck to load up Ma, Tom, Rose-of-Sharon, and the rest of the Joad clan to head out Californ-i-way. At least you’ll have a great engine to help you get there.

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