Should I Buy Caterpillar? 3 Pros, 3 Cons

by Tom Taulli | July 11, 2012 2:02 pm

Should I Buy Caterpillar? 3 Pros, 3 Cons

012BestStocks 185x185Logo Should I Buy Caterpillar? 3 Pros, 3 Cons[1]Yesterday’s downbeat announcement from diesel-engine maker Cummins (NYSE:CMI[2]) was another sign that the global economy is weakening. For 2012, the company sees flat revenue growth — and yes, the news sent shock waves across the heavy equipment sector. One of the notable stocks that got hit was Caterpillar (NYSE:CAT[3]), which fell by 3.5%.

It’s no wonder, considering that CAT has recently been facing some headwinds. The stock, one of InvestorPlace‘s top picks for 2012[4], is down by 12% in year-to-date. But might the drop be an overreaction?

To decide, let’s take a look at the pros and cons:

Pros

Mega Player. Caterpillar is the No. 1 manufacturer of construction machinery, with a diverse line of offerings. These include bulldozers, backhoe loaders and wheel excavators.

To build its portfolio, Caterpillar has been aggressive with acquisitions. Over the years, it has purchased operations like FCM Rail, an equipment leasing firm, and the Inspection Products business from General Electric (NYSE:GE[5]).

But the most important deal was the $8.6 billion acquisition of Bucyrus International. The company builds mining equipment for surface and subsurface industries.

Financial Powerhouse. With the strength in global commodities markets, Caterpillar has seen robust growth. Since 2007, revenues have climbed about 34% to $61 billion.

The company is also a big cash flow generator. For 2011, operating cash flows came to about $7 billion. As a result, Caterpillar has sufficient resources to pay an attractive dividend of 2.5%.

Dealer System. This has been a major key for Caterpillar’s success. The company has an extensive network across the U.S. and 138 foreign countries.

While the dealer system has been important for sales, it has also been key in providing ongoing services. After all, customers want to make sure their equipment suffers from little downtime.

Cons

Cyclical Business. The commodities industry is highly sensitive to moves in the global economy. Unfortunately for CAT, it looks like growth is starting to falter. This appears to be the case in some key markets, such as China and Brazil.No doubt, it’s easy for customers to hold off on making big purchases, which could put a big hurt on Caterpillar’s revenues.

Competition. CAT has only a handful of serious rivals because of the intense consolidation in the industry. Yet the competitive environment is still intense. Besides Japan’s Komatsu (PINK:KMTUY[6]), emerging players in China are putting pressure on Caterpillar.

Regulations. Both the U.S. and Europe have passed extensive legislation on emissions standards. While Caterpillar has been able to upgrade its vehicles, the costs have been substantial. The result will likely be a pinch on margins.

Verdict

For the long haul, Caterpillar’s prospects look bright. The company will be a main beneficiary of infrastructure growth in the emerging countries.

However, the main issue is the short run. The news from Cummins is certainly something for investors to be worried about. Is there a major slowdown in the industry? If so, Caterpillar’s stock could be vulnerable to further deterioration.

So in light of this, the cons outweigh the pros on the stock for now.

Tom Taulli runs the InvestorPlace blog IPO Playbook, a site dedicated to the hottest news and rumors about initial public offerings. He is also the author of the upcoming book How to Create the Next Facebook: Seeing Your Startup Through, from Idea to [7]IPO[8].  Follow him on Twitter at @ttaulli[9] or reach him via email[10]. As of this writing, he did not own a position in any of the aforementioned securities.

Endnotes:
  1. [Image]: http://investorplace.com/best-stocks-for-2012/
  2. CMI: http://studio-5.financialcontent.com/investplace/quote?Symbol=CMI
  3. CAT: http://studio-5.financialcontent.com/investplace/quote?Symbol=CAT
  4. InvestorPlace‘s top picks for 2012: http://investorplace.com/best-stocks-for-2012/
  5. GE: http://studio-5.financialcontent.com/investplace/quote?Symbol=GE
  6. KMTUY: http://studio-5.financialcontent.com/investplace/quote?Symbol=KMTUY
  7. How to Create the Next Facebook: Seeing Your Startup Through, from Idea to : http://goo.gl/RVJL9
  8. IPO: http://goo.gl/RVJL9
  9. @ttaulli: https://twitter.com/ttaulli
  10. email: mailto:tom@taulli.com

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