Cummins, Inc' CUM Credit Analysis

1
Cummins, Inc. (CUM)Credit Analysis

• Yasmin Hussain
• Mark Kilduff
• Joe Toomer
• April 8, 2002

2
Business Overview

• Global leading manufacturer of engines (diesel
  and natural gas) for
• medium and heavy duty trucks,
• motor homes,
• and buses.
• Global supplier of power generation sets and
  advanced filtration and exhaust systems
• 5.7B - 2001 Revenues

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Business Segment Snapshot
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Engine Business Segment

• 22.9 decline in Engine Sales from 2000
• Improving US Economy will position Cummins to
  regain market share of heavy duty truck market
• New truck inventory at manageable level
• Large number of used trucks declining in recent
  months
• Demand volatility in next 12 months due to
  pre-buying around new engine EPA emission
  standard

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Power Generation Filtration Business Segments

• Power Generation
• Not very optimistic for power generations sets.
• Margins pressured by increased competition
  resulting in industry pricing to fall.
• Filtration
• Leading in filtration, air intake and exhaust
  systems,
• Forecast higher operating leverage for Filtration
  through Nelson acquisition.

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Historic Leverage (excludes Mezzanine Debt)
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Why Did Leverage Change?

• In 1998, Cummins issued 765M to fund acquisition
  of Nelson Industries
• In 2000, Cummins began efforts to reduce debt
  levels
• Moderate success
• Most recent leverage numbers exclude hybrid
  mezzanine securities

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Recent Debt Market Activity

• Quasi debt issue (June 2001)
• 291M Convertible cumulative quarterly income
  preferred securities (QUIPS)
• Type of Trust Preferred Security
• Coupon 7
• Potential for deferred coupon payments
• Conversion rate 1.0519 (price 47.53)
• Current stock price 47.36

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Debt Capacity Does Cummins Have Too Much Debt?

• How should we assess Cummins debt capacity?
• General financial performance
• Debt as a percentage of capital structure
• Interest coverage
• Comparable company analysis

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General Financial Performance
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Ratio Analysis
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Standard Poors Average Ratios
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Implied Credit Strength

• EBIT Coverage 1.1x ?
• EBITDA Coverage 4.1x ?
• Debt/Capital 54.7 ?

• Implied Rating B
• Implied Rating BB
• Implied Rating BB

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Liquidity Requirements/ Sources

• Obviously, interest payments
• 1999 82M
• 2000 88M
• 2001 80M
• Principal repayment
• 2002 10M
• 2003 133M
• 2004 7M
• 2005 232M
• 2006 7M
• Sources Operations
• 1999 EBIT -42M
• 2000 EBIT 89M
• 2001 EBIT 296M

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Receivable Securitization A Sign of Desperation
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Additional Liquidity Issues

• The Company completed several sale-leaseback
  transactions
• Earned profits
• Significant Net Working Capital
• Some security for debt holders

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Covenants

• Restricting declaration and payment of any
  dividend so long as the Trust Preferred
  securities are outstanding
• Will not make any payment of principal, interest
  or premium, if any, on or repay or repurchase or
  redeem any debt securities that rank equally with
  or junior to outstanding debentures
• Maintain minimum net worth
• Maintain investment grade rating or it will cross
  default on many of its financings

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What could trigger covenants?

• Cummins has guaranteed 49 million of debt of its
  domestic and international distributors!

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What could trigger covenants?

• Net income and cash flow (EBITDA) have been
  decreasing, straining coverage ratios and
  jeopardizing investment grade (BBB-/Baa3) rating

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What could trigger covenants?

• In a down equity market, the company may not be
  able to issue additional equity, additional debt
  financing could trigger the minimum net worth
  covenant

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Collateral

• Net fixed assets total 1.4 billion.
• Cummins has a debt to total assets ratio of 28.2
• Considering off balance sheet financing, this
  ratio is 40.

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Recommendation Short

• Regulatory risk of not receiving EPA approval for
  engines
• Current financial performance warrants high
  yield rating
• Cross-default covenant raises probability of junk
  status