Cummins Inc . The industrial giant, NYSE:, has a competitive edge.

The company designs, manufactures, distributes, and services diesel and engines, electric and hybrid powertrains, and related components worldwide.

The company operates in five areas: Engine, Distribution and Components. It also offers power systems, new power, and components.

We are neutral on Cummins’ forward multiple. However, we think we might be able get better entry points in the near-term. (See Cummins stock charts on TipRanks)

Measuring Its Competitive Advantage

We can measure Cummins’ competitive advantage by comparing its earnings power value to the value of reproducing the business. Adjusted EBIT after taxes is multiplied by the average weighted capital cost. The reproduction value of Cummins can be measured with total assets value. A company with a higher earnings power value than its reproduction value will be considered competitive.

Cummins’ average EBIT margin over the past five years was 10.4%. Using its revenue for the last 12 months, its adjusted EBIT is as follows:

$23.2 billion x 0.104 = $2.41 billion

Using a marginal tax rate of 22%, the after tax adjusted EBIT is $1.88 billion.

Cummins’ weighted average cost of capital is 6.8%. Earnings power value equals $27.65 billion (1.88 billion multiplied by 0.068).

Finally, its total asset value is $22.61 billion. Cummins is therefore competitive because it has an earnings power value that exceeds the business’ reproduction value.

Growth Catalysts, Risks

Cummins is currently trading at 15.3 times earnings and approximately 11.5 times forward earnings.

Since the company is cyclical, it’s more sensitive to business cycles. Its P/E ratio is usually between 10 and 20. Cummins generates a lot free cash flow, which is used regularly for buybacks and dividends.

The company’s share count continues to decrease every year as a result of the buybacks. Even if earnings remain flat, earnings per share will rise. Even though the historical P/E ratio is unchanged, an increase in EPS will result in a greater share price.

In fact, Cummins’ EPS remained relatively flat from 2011 to 2016 despite seeing earnings decline over that same period. Although the stock trended upwards during this period, it was volatile. It is clear to see the positive impact share buybacks have.

Cummins also benefits from its involvement in green technology development. The company’s focus is on hydrogen energy. It’s already powering some trains in Europe with its fuel cells, in addition to other applications, ranging from grocery trucks to the first PEM electrolyzer in the United States.

However, like many manufacturers these days, Cummins is vulnerable to supply chain disruptions that lead to uncertainties about the company’s operations.

On top of that, increased costs of raw materials may impact the company’s margins if it’s not able to pass on the expense. There is also the risk of cyclical events in the sector.

Wall Street’s Take

Turning to Wall Street, Cummins has a Moderate Buy consensus rating, based on four Buys and five Holds assigned in the past three months. The average Cummins price target of $278.67 implies 27.1% upside potential.

Final Thoughts

Cummins is undoubtedly an industry leader, with a measurable competitive advantage.

Cummins stock is the most resilient to a market downturn due to its cyclical nature. The stock has been on a downward trend for months now, and it’s possible that we are nearing a bottom.

Unless you can stomach a lot of volatility, it’s better to wait for momentum to pick up towards the upside before entering industrial stocks.

Stock Bros Research was not aware of any positions in the securities discussed in this article at the time it was published.

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