Cummins India Stock Falls On Concerns Over Draft Bill To Cut Diesel Genset Use
Shares of Cummins India Ltd. declined after India invited feedback to a proposed legislation aimed at providing round-the-clock power and reducing usage of polluting diesel generators.
The Draft Electricity (Rights of Consumers) Amendment Rules 2021 gives diesel genset users five years—or a time granted by respective states—for shifting to cleaner technology from the date of the amendment.
Brokerages viewed this as a "structurally negative" development for Cummins India, the market leader in high and medium horsepower diesel gensets in India.
The news led to Cummins India shares dropping over 8% in intraday trading on Oct. 1, compared to the Nifty's 0.6% fall. The stock has been falling for four straight sessions.
Shares of the company fell as much as 3.2% to Rs 888.45 on the NSE. Of the 34 analysts tracking the company, 20 have a ‘buy’ rating, six suggest a ‘hold’ and eight recommend a ‘sell’, according to Bloomberg data. The average of the 12-month consensus price targets implies an upside of 7.2%.
Here's what brokerages said about the draft bill's impact on Cummins India:
Maintains 'sell' rating with a target price of Rs 695 per share, implying a potential downside of 24%.
The timelines are ambiguous and based on the reliability of supply by the distribution company in that particular city. The draft bill states that consumers using diesel gensets should shift to cleaner technology within five years from the date of publication of the amendment or as per the timelines given by the state commission.
Since this bill is a draft and does not talk about the blanket ban on diesel genset usage, no material impact is expected in the near term. However, it does take away a portion of the addressable market in metros as well as prospective customers over the medium term.
We carry a structurally negative view on diesel gensets, particularly on account of improvement in power availability leading to the lower utility value of generators.
Further, disruptions from solar energy and battery storage, among others, would only limit category growth. Notably, domestic powergen forms 27% of Cummins India’s revenue. The distribution segment (28% of revenue) drives growth from the installed bases of the powergen and industrial segments. Thus, there may be a risk to growth for 40–45% of Cummins India’s long-term revenue.
Cummins India is a potential exports story (better captured in the unlisted entity) and fails to impress us as a proxy to domestic capex. We prefer L&T as the best play on domestic capex.
Maintains 'underperform' rating with a target price of Rs 620, implying a potential downside of 37.8%.
The domestic powergen segment, which is about 30% of Cummins India's revenue, includes sales coming from mid-range, heavy duty and high horsepower categories. These categories cater to large establishments (shopping malls, commercial offices) and mission critical applications (hospitals, airports) which, in our view, will continue to install backup sets even if there is 24x7 power promise from the government.
In our view, the only demand pullback could be seen in the low horsepower segment that accounts for a small 3-4% portion of the total topline as per our assessment based on historical data.
In our view, the probability of such an event playing out is low because the alternative of battery storage for backup powergen is currently impractical for non-utility scale applications given the power density limitations of that system.
The stock decline is probably a result of sentimental impact of this government document rather than its financial impact.
In our view, the business impact on Cummins India will be limited from the proposed rules and it does not materially change the outlook for key segments of Cummins India and does not pose a risk to fundamental multiples.
Our rating on Cummins India emanates from expensive valuation and the elusive, unconfirmed market-anticipated merger of Cummins India with the unlisted parent entity Cummins Technologies India.
Maintains 'underperform' rating, with a target price of Rs 530, implying a potential downside of 46.5%
The draft, if finalised, is a negative for the medium-term outlook of diesel gensets and Cummins.
Maintains ‘reduce’ rating with a target price of Rs 666, implying a potential downside of 27.4%.
Draft electricity rules reinforce our view of structural challenges to diesel-based power; challenges emerge for diesel gensets and engines in back-up power and construction in addition to existing headwinds on railways.
We expect headwinds for the distribution segment, while the longer term replacement of diesel gensets as a means of back-up power by consumers reduces the installed equipment base for Cummins India and thereby impacts demand for spares and services.
Distribution is a relatively higher-EBITDA-margin business than the rest of Cummins India’s portfolio, and thus, its profitability can be impacted.
The impact on powergen business from construction power demand can also be significant. Infrastructure accounted for 20% of Cummins India’s powergen sales in FY19. The combined effect on distribution and powergen can be significant if the draft legislation is enforced.
Even in data centres, there is a conscious thrust to move away from diesel as a back-up power to the usage of battery technology, hydrogen fuel cells or even advanced data analytics tools like Microsoft Azure to implement the green data centre concept. While this may not be an immediate threat to Cummins India, the same can be a challenge in the long term.
Key risks include stronger-than-estimated benefits from cost reduction initiatives, and stronger than expected domestic and exports demand.
It is best to avoid both Cummins India and Kirloskar Oil Engines for now.
The draft rules pose a serious concern on the survival of diesel generating set manufacturers like Cummins India and Kirloskar Oil Engines even though we would argue that the rules are very aggressive and impractical to be implemented over the proposed time frame of five years.
It poses a structural concern over the existing domestic business (50-80% of revenues) of the diesel genset manufacturers. Investors should keep away from these stocks until there is clarity on the final rules and/or alternate fuel technology capability from these players.
Global players like Cummins India already have technology to counter this measure with hydrogen fuel-based gensets and battery empowered gensets working globally. However, these offerings are still niche and not core for Cummins India. It will be optimistic to expect Cummins India to be able to move its portfolio to offerings with battery backup as it is not the company’s core and will always be a trading business, offering very little value addition and margins.
The best-case scenario is that the circular is withdrawn and not implemented for now. It's a concern over the longer term that the diesel genset business will gradually decline and not have a terminal value, making it structurally negative.
Kotak Institutional Equities
Maintains ‘buy’ rating on the stock, with a fair value of Rs 1,080, implying a potential upside of 17.6%.
Do not see the rationale of a big change in demand for diesel gensets in India on the promise of a more reliable supply of electricity. Nor do we see the case for a big shift to green fuels for gensets as a means to lower pollution levels in cities.
The power generation data for Cummins Global suggests a healthy 12% growth over CY2014-19 for North America. This reflects the relevance of the diesel genset as an insurance against grid failure. While such need for insurance is mature in developed markets, it may still continue to grow within the Indian context.
Large-scale applications may shift from diesel genset backup based on improved battery storage capabilities. Data centres would account for mid-to-high single-digit share of Cummins India’s revenues by FY2024.