Diesel-engine maker Cummins CMI + 0.32% revealed plans to buy truck parts maker Meritor mTOR + 45.54% in a deal that shows good things can happen with cheaper stocks. The transaction also makes clear that Cummins knows that heavy-duty trucks need to become more environmentally friendly.
Cummins (ticker: CMI) will pay $36.50 in cash for Meritor MTOR + 45.54% (mTOR). That's 48% higher than Meriter stock's $24.67 that closed Friday.
Meritor stock was at $35.25 in premarket trading Tuesday, down $1.25, or 3.4%, from the deal price. Trading below the deal price could mean investors don't expect a bidding war to begin. At a little over 3%, the discount is so low that investors don't expect any antitrust problems to emerge. This equals the return investors need to hold the stock from now until the close of the deal.
Cummins says the transaction should close by the end of 2022.
Cummins stock was down 0.6% in premarket trading. Futures were flat on the S&P 500 SPX-0.11% and the Dow Jones Industrial Average DJIA-0.52%.
“The acquisition of Meritor is a significant milestone for Cummins. Meritor is an industry leader, and the addition of their complementary strengths will help us address one of the most critical technology challenges of our age: of commercial and industrial applications. To develop an economically viable zero carbon solution,” said Cummins CEO Tom Lineberger in a company news release.
Buying a traditional truck parts manufacturer may not be motivated by the need to address climate change, but Meritor also makes parts for electric trucks, such as axles that have integrated electric motors.
Although Cummins makes a lot of diesel engines, it is also investing in electric powertrains and hydrogen technology. Hydrogen gas can be burned or used to power fuel cells that generate electricity. And neither process involves the emission of carbon dioxide, the main gas responsible for climate change.
Barron wrote positively about Meritor in October, conceding that investors were underestimating the company's opportunity to increase the amount of its parts used in electric trucks. Investors were treating Meritor as a traditional truck-parts supplier that ran the risk of being disrupted by new technologies.
Coming into Tuesday's trading, Meritor stock traded at less than 7 times projected earnings per-share for 2022, while Cummins valued it at nearly 10 times. That's closer to the valuation of more diverse auto-parts suppliers. For example, BorgWarner trades at BWA-0.14% (BWA), nearly 10 times its expected 2022 earnings.
The deal could have a positive impact on other small-capitalization auto- and truck-part suppliers with lower price-to-earnings ratios. American Axel & Manufacturing AXL-0.30% (AXL) stock, for example, trades for about 6 times projected 2022 earnings. Its shares were up about 1% in premarket trading. Tenneco trades for TEN-0.19% (TEN) about 2 times projected 2022 earnings, but trading volume in the stock was light ahead of Tuesday's open. Price remained unchanged.