Cummins Inc. (NYSE:CMI)

The period under review demonstrates a declining trend in economic profit. While positive in 2019, economic profit transitioned to negative values and continued to decrease through 2023. This decline is attributable to a combination of fluctuations in net operating profit after taxes, changes in the cost of capital, and increases in invested capital.

Net Operating Profit After Taxes (NOPAT)

NOPAT experienced a decrease from US$2,609 million in 2019 to US$2,018 million in 2020, followed by a recovery to US$2,585 million in 2021. A further decline to US$2,348 million occurred in 2022, culminating in a substantial reduction to US$1,014 million in 2023. This represents the most significant factor contributing to the overall decline in economic profit.

Cost of Capital

The cost of capital exhibited a slight decrease from 15.86% in 2019 to 15.48% in 2021. It then increased to 14.83% in 2022 before rising again to 15.20% in 2023. While fluctuations were present, the cost of capital remained relatively stable overall, and did not drive the observed trend in economic profit.

Invested Capital

Invested capital increased consistently throughout the period. From US$15,235 million in 2019, it rose to US$17,479 million in 2020 and US$17,518 million in 2021. A more substantial increase was observed in 2022, reaching US$22,657 million, followed by a slight decrease to US$20,768 million in 2023. The increasing invested capital base, coupled with declining NOPAT, exacerbated the negative trend in economic profit.

Economic Profit

Economic profit began at US$192 million in 2019. It then became negative in 2020 at -US$714 million, and continued to worsen, reaching -US$2,143 million in 2023. The magnitude of the negative economic profit increased significantly over the period, indicating a growing disparity between returns generated and the cost of capital employed. The largest decrease occurred between 2022 and 2023.

In summary, the observed decline in economic profit is primarily driven by the reduction in NOPAT, compounded by the increasing levels of invested capital. While the cost of capital experienced some fluctuation, its impact was less pronounced than the other two factors.

The financial data reveals fluctuations in both net income and net operating profit after taxes (NOPAT) over the analyzed period.

Net income attributable to Cummins Inc.

Net income exhibited variability, beginning at 2,260 million USD in 2019 and decreasing sharply to 1,789 million USD in 2020. This was followed by a recovery in the subsequent years, rising to 2,131 million USD in 2021 and maintaining a similar level at 2,151 million USD in 2022. However, 2023 witnessed a significant decline, with net income dropping markedly to 735 million USD, which is substantially lower than any previous year in the period.

Net operating profit after taxes (NOPAT)

NOPAT displayed a somewhat parallel trend to net income. It started at 2,609 million USD in 2019, decreased to 2,018 million USD in 2020, then rebounded to 2,585 million USD in 2021. In 2022, there was a slight decrease to 2,348 million USD. Nevertheless, 2023 saw a pronounced decline, with NOPAT falling to 1,014 million USD. Although this drop is severe, it is less steep in percentage terms compared to net income.

Overall, the data suggests that while the company recovered from a downturn in 2020, its profitability experienced a substantial setback in 2023. The net income decline is especially pronounced relative to previous years, indicating potential issues affecting bottom-line results more acutely than operating profits. Further investigation into the causes behind the 2023 decline would be necessary to understand the underlying factors impacting financial performance.

The financial data reveals a consistent upward trend in both income tax expense and cash operating taxes over the five-year period from 2019 to 2023.

Income Tax Expense

This expense decreased slightly from 566 million USD in 2019 to 527 million USD in 2020. However, from 2020 onward, a steady increase is observable, with values rising to 587 million USD in 2021, 636 million USD in 2022, and reaching 786 million USD in 2023. This indicates a growth of approximately 49% over the five-year span from the minimum point in 2020 to 2023.

Cash Operating Taxes

Cash operating taxes exhibit a similar pattern. Starting at 596 million USD in 2019, there was a decline to 544 million USD in 2020. Following this, a significant rise is evident: 606 million USD in 2021, surging to 956 million USD in 2022, and further increasing to 1,326 million USD in 2023. This reflects a more pronounced growth trajectory, with cash operating taxes more than doubling from 2020 to 2023.

Overall, while both income tax expenses and cash operating taxes experienced slight declines in 2020—potentially due to economic effects impacting that year—the subsequent years show substantial increases. The growth in cash operating taxes is especially marked in the latter years, indicating either higher taxable operating income or changes in tax payment patterns. These upward trends suggest increasing tax-related outflows that may impact the company’s net earnings and cash flow positions.

Total reported debt & leases

The total reported debt and leases demonstrated a notable increase from 2019 through 2022, rising from $2,868 million to $8,355 million. This marks a nearly threefold increase over the four-year period. However, in 2023 there was a decrease to $7,208 million, suggesting a partial reduction in debt levels after the peak in 2022.

Total Cummins Inc. shareholders’ equity

Shareholders' equity showed consistent growth throughout the entire period. It started at $7,507 million in 2019 and increased annually to reach $8,975 million in 2022. The value slightly declined to $8,850 million in 2023, indicating a minor reduction but overall maintaining a stable upward trend over the five years.

Invested capital

Invested capital increased steadily from $15,235 million in 2019 to $17,518 million in 2021. A significant rise occurred in 2022, reaching $22,657 million. In 2023, invested capital decreased to $20,768 million, which, while lower than the previous year, remains notably above earlier levels. This pattern suggests an expansion phase followed by a moderate contraction.

The economic spread ratio exhibited a markedly declining trend over the five-year period. Initially positive, the ratio transitioned to negative values and demonstrated increasing negativity throughout the observed timeframe. This suggests a worsening trend in the company’s ability to generate returns exceeding its cost of capital.

Economic Spread Ratio

In 2019, the economic spread ratio stood at 1.26%, indicating that the company generated returns exceeding its cost of capital. However, this positive spread reversed sharply in 2020, falling to -4.09%. The ratio remained negative in 2021 at -0.72%, before declining further to -4.47% in 2022. By 2023, the economic spread ratio had reached -10.32%, representing a substantial deterioration in profitability relative to invested capital.

The economic profit figures correlate with the economic spread ratio. Positive economic profit in 2019 aligns with the positive spread. Subsequent years show negative economic profit, mirroring the negative and worsening economic spread ratio. The magnitude of the negative economic profit increased each year, from US$714 million in 2020 to US$2,143 million in 2023, reinforcing the trend of diminishing value creation.

Invested Capital

Invested capital increased from US$15,235 million in 2019 to US$17,479 million in 2020 and US$17,518 million in 2021. A more significant increase was observed between 2021 and 2022, reaching US$22,657 million. However, invested capital decreased slightly in 2023 to US$20,768 million. While invested capital generally increased over the period, the declining economic spread ratio indicates that these investments did not generate commensurate returns.

The combination of a decreasing economic spread ratio and fluctuating invested capital suggests that the company’s profitability has not kept pace with its capital deployment. The increasing negativity of the economic spread ratio, coupled with the growing magnitude of negative economic profit, warrants further investigation into the underlying drivers of performance.

The economic profit margin exhibited a concerning downward trend over the five-year period. Initially positive, it transitioned to negative values and continued to decline in magnitude. This suggests a deterioration in the company’s ability to generate returns exceeding its cost of capital.

Economic Profit Margin

In 2019, the economic profit margin stood at 0.81%. This indicates that for every dollar of sales, the company generated 0.81 cents of economic profit. However, this positive margin was short-lived. A significant decline was observed in 2020, with the margin falling to -3.57%. This represents a substantial shift, indicating that the company was destroying economic value. The margin remained negative in 2021 at -0.52%, showing a slight improvement but still representing an economic loss. Further deterioration occurred in 2022, with the margin reaching -3.59%, and continued to worsen in 2023, ending at -6.23%. This represents the largest economic loss over the observed period.

The trend in economic profit mirrors the economic profit margin. While a profit of US$192 million was recorded in 2019, subsequent years saw substantial losses. The largest loss occurred in 2023, reaching US$2,143 million. This negative economic profit directly contributes to the declining economic profit margin.

Relationship between Adjusted Net Sales and Economic Profit Margin

Despite an increase in adjusted net sales from US$19,988 million in 2020 to US$34,403 million in 2023, the economic profit margin continued to decline. This suggests that the increase in sales was not sufficient to offset rising costs or a decline in profitability, or that the cost of capital increased significantly. The inability to translate increased sales into positive economic profit is a key concern.

The consistent negative economic profit margin, coupled with the increasing magnitude of the losses, indicates a fundamental issue with the company’s profitability relative to its capital costs. Further investigation into the underlying drivers of these trends is warranted.