Build Me A Bridge

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Stock Pick: Cummins Inc. (CMI-US, $49.5B MCAP)

It’s time to get back to building.

Frequent readers are now well aware of the renaissance we are undergoing in the U.S. power grid. We’ve discussed nuclear’s role in this at length, and those stocks have performed spectacularly.

HOWEVER. This solution is not a NOW solution. We need to build a bridge.

Crumbling electrical infrastructure cannot be miraculously solved by nuclear overnight because building new reactors is a slow and arduous process. YES — there will be less red tape under the current administration, but we need a transition solution.

This is exactly where this week’s pick comes in.

Elon Musk famously set up a massive data center in record time that blew away his deep-pocketed rivals. He made a huge gamble and it paid off big time — but he also had an ace up his sleeve when it comes to a backup plan. Time for a story.

• Why now? 👉 The Elon Example

• Overview 👉 What Does Cummins Do?

• Business Segments 👉 Breakdown

• By The Numbers 👉 Key Metrics

• Risks 👉 Potential Pitfalls

• Wrapping Up

Why now? 👉 The Elon Example

We are in the midst of three key bottlenecks when it comes to the proliferation of artificial intelligence: semiconductors, supplementary data center components, and power.

As of November 2024 — there are approximately 199 data centers under construction as we ramp up capacity. This is all net-new demand that will stress grids.

Elon Musk is in the process of building a 100,000 GPU supercomputer known as Colossus. When he huddled his team around the table to get this online, the main concern was that access to enough power to support the chips would be extremely difficult. At first, it looked like a non-starter.

But Musk came up with a stopgap solution: He brought in mobile, natural gas–powered turbines to provide supplemental power while he waited for local authorities to approve a request for an additional 100 megawatts of power at the site. This got approved last week and the gamble paid off.

Now — I tell this story because it’s an anecdote of the overall electrical grid at large. We need solutions over the near term to match this spike in demand before we can move to longer-term nuclear solutions.

So let’s dig into this week’s pick.

Overview 👉 What Does Cummins Do?

Cummins Inc. is a global powerhouse specializing in the design, manufacture, and distribution of engines and power generation products. Their core offerings include diesel and natural gas engines that serve a wide array of markets such as automotive, industrial, marine, and construction. With a reputation built on reliability and durability, Cummins engines are integral components in heavy-duty trucks, buses, and commercial vehicles worldwide.

Beyond traditional engines, Cummins has diversified into related technologies and services. The company provides advanced solutions in filtration, turbochargers, fuel systems, controls, and emission control technologies. They also have a significant presence in power generation equipment, offering generators and alternators for both standby and prime power applications, catering to sectors like data centers, healthcare, and telecommunications.

Recognizing the shift toward sustainable energy, Cummins is investing heavily in emerging technologies like electrification, hydrogen fuel cells, and battery systems. Their commitment to innovation positions them at the forefront of the transition to cleaner energy solutions. By expanding their portfolio to include low- and zero-emission technologies, Cummins aims to meet evolving regulatory standards and customer demands, ensuring long-term growth and relevance in a changing global market.

Business Segments 👉 Breakdown

Cummins Inc. organizes its operations into five main business segments, each focusing on different aspects of the power and engine industry:

Engine Segment: This core segment designs and manufactures diesel and natural gas engines for a variety of applications. These engines power heavy and medium-duty trucks, buses, recreational vehicles, light-duty automotive vehicles, and equipment in the construction, mining, marine, rail, and agricultural markets.

Power Systems Segment: Formerly known as the Power Generation segment, it offers a broad portfolio of power solutions. Products include standby and prime power generator sets, alternators, switchgear, and other components for power generation systems. The segment serves industries that require reliable power, such as data centers, healthcare facilities, and commercial buildings.

Components Segment: This segment supplies key engine components, both for Cummins engines and those of other manufacturers. Its offerings include after-treatment systems to reduce emissions, turbochargers for engine efficiency, fuel systems for optimal performance, filtration products for engine longevity, and electronic control systems.

Distribution Segment: The Distribution segment manages a global network of company-owned and independent distributor locations. It provides sales, service, and support for Cummins products, ensuring customers worldwide have access to parts, maintenance, and technical expertise. This segment enhances customer service by offering localized support.

New Power Segment (Accelera): Focused on the future of energy, this segment develops and commercializes alternative power technologies. It includes electrified power systems, hydrogen fuel cells, and battery solutions. The New Power segment represents Cummins' commitment to innovation and meeting the evolving demands for cleaner, more efficient power sources.

By The Numbers 👉 Key Metrics

Looking at a quick snapshot of the company overall, we can paint a picture of continuing to moderate revenue growth after a cyclical trough with an upside to operating leverage.

Each of the different segments has its own unique operating metrics. Growth rates vary depending on cyclicality while EBITDA margins are also stronger in certain areas (power systems).

The company provides guidance on a forward looking basis. I like to focus on companies that are reaching positive net inflection when it comes to projected earnings improvement. As you can see in the revised guidance, the company has recently been moving its goal posts out:

While the Engine and components businesses are forecasted to experience a moderate slowdown, our focus here is more on power systems and distribution over the near-term. Here, we can see improving growth:

In terms of stock performance, this name has been a staple combining growth with a moderate dividend, for an annual CAGR of 17.8% over the last 5 years:

Risks 👉 Potential Pitfalls

Cyclical Industry and High Operating Leverage: Cummins operates in a machinery sector that is highly cyclical. Economic downturns can sharply reduce demand, and with high fixed costs, this can significantly impact profitability.

Regulatory and Environmental Compliance: The company faces strict environmental regulations that require constant investment in compliance. Future changes could increase costs or limit market access if not met.

Technological Disruption and Competition: Rapid advancements in alternative energy technologies pose a threat. Failure to innovate or adapt could lead to loss of market share to competitors embracing new power solutions.

Wrapping Up…

This is a perfect example of what I call expertise transfer. They got incredibly good at one thing (power systems) and have applied this know-how across several different industries and product lines.

Don’t think of this as a direct play on data centers, rather as a play on powering the energy transition over the short term while we build out longer term capacity.

This stock is a perfect example of one of our favorite mantras: Boring is Beautiful.

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Cheers,

The GRIT Alpha Team

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