Cummins, Inc. – The Repatriation Effect

Cummins, Inc. (CMI)

The impact of the Tax Cuts and Jobs Act of 2017 is clearly in play when it comes to Cummins, increasing their y-o-y effective tax rate from 27% to 58%. This increase impacts investors that focus on earnings as the central valuation metric. In this instance, my valuation for the company was impacted a great deal because instead of using earnings of $7.57 (assuming a three year averaged tax rate of 26.88%) per share, I had to use $3.13. Welcome to the repatriation of income.

For most companies in this situation, the final tally for repatriated income is still being finalized with any adjustments for FY17 taxes applied in FY18. That, of course, will have somewhat of an impact on FY17 earnings and my valuations, but for now, I have to go with what is on the books and not what may be or would have been since using those “tax adjusted numbers” would make my valuation a Pro Forma valuation, something many of us learned about first hand in the late 1990s.

The diesel engine maker’s sales saw a y-o-y increase of 17%, but because of the repatriation of income taxes, earnings fell by 56% and free cash flow fell by 49%. More normalized earnings would have seen the company with the same y-o-y sales increase, but earnings would have increased by 7% and free cash flow would have increased by an increase of 9%. Regardless of the effective tax rate used, debt grew by 8%.

One event I found significant for FY17 was the company’s 50% joint venture with Eaton Corporation Plc (NYSE: ETN). The joint venture is going to design, assemble, sell and support medium-duty and heavy-duty automated transmissions for the commercial vehicle market. This should allow the company to increase sales and earnings while sharing the associated financial risks.

So what’s this deal? My short-term (3-6 week hold) target price for the stock is $187.52, with an initial trailing stop at $166.99. My current future target price for the stock (a 5-year hold) is $278, which is an average annual return of 13%. A prior five-year hold of the stock would have returned an average of 13% per year. Please remember that any investment has the potential for loss and that past performance is no guarantee of future results.