Should I Buy Caterpillar? 3 Pros, 3 Cons

by Tom Taulli | July 25, 2013 10:00 am

2013 has been more rough than not for Caterpillar (CAT[1]), whose stock is off nearly 7% year-to-date and 16% off its February highs. And the company’s second-quarter earnings report only reinforced the idea that CAT’s woes are not temporary.

Specifically, earnings plunged 44% year-over-year to $960 million ($1.45 per share), while revenues slumped 16% to $14.62 billion. Both figures came in shy of expectations for earnings of $1.69 per share on revenues of $15.09 billion.

Caterpillar’s big problem was its mining equipment division; with the commodities market cooling off, demand has contracted substantially.

Still, sometimes the best time to buy is when the situation looks bleak. So should you buy Caterpillar as a potential bargain, or is there no hope for a meaningful bounce anytime soon? To see, let’s look at the pros and cons:

Pros

Global Power: CAT is the world’s largest manufacturer of construction and mining equipment, producing things like backhoe loaders and pipelayers on the construction side, as well as electric rope shovels and tunnel boring equipment on the mining side. Much of the latter business came from the $8.8 billion acquisition of Bucyrus International back in July 2011. There also is Cat Financial, which provides equipment financing — a key business to promote sales and boost margins.

Dealer System: This has been a major competitive advantage. CAT has put together a distribution network including 3,500 places of business across 48 states and 141 countries. These are not just for selling products; CAT dealers also are important for ongoing services and maintenance.

Valuation: Caterpillar stock is priced reasonably at a forward price-to-earnings ratio of 10. Meanwhile, CAT has increased its dividend over the years, including a June hike of 15% that boosted its annual dividend yield to 2.8%.

Cons

Competition: Rivals are numerous in both of Caterpillar’s core markets. Within construction, CAT must fight against tough operators like Komatsu, Volvo Construction Equipment, CNH Global (CNH[2]), Deere (DE[3]) and Hitachi Construction Machinery. As for mining, the rivals include some of the same players like Komatsu and Hitachi but also Joy Global (JOY[4]), Atlas Copco and Wirtgen. Although, there are variety of operators in China — including Beijing Shougang Construction Group, LiuGong Machinery and Zhengzhou Coal Mining Machinery Group — that could turn into big threats.

Jim Chanos: He is a legendary short seller, having made a bundle on the implosion of companies like Enron … and unfortunately for Caterpillar shareholders, he thinks CAT looks like a great short, according to a presentation at CNBC’s “Delivering Alpha” conference. Chanos points out that China is slowing down, and this will mean cutbacks in mining equipment. In fact, about 50% of operating profits come from this segment[5]. Said Chanos: “(Caterpillar) is an iconic American company, a leader in its class, but it is in the wrong products at the wrong time in the cycle. Now, earnings are not expected to grow reasonably at all for the next few years.”

Carbon Emission Regulations: Governments across the world are taking steps to cut back on emissions so as to deal with the risks of global warming. While CAT has invested in systems for this, it has been expensive and could pressure margins.

Verdict

CAT provided a bleak full-year forecast that includes EPS expectations of $6.50, down from prior guidance of $7 per share and well off last year’s $8.48 per share. Sales are forecast in a range of $56 billion to $58 billion, well down from last year’s $65.9 billion.

But you can bet that these projections are intentionally conservative, and maybe that — and the fact that so much bad news has already been baked in — is why CAT didn’t sell off too heavily after the fact.

Caterpillar remains an industry powerhouse and should recover once the global economy finally starts kicking, plus its dividend provides a decent cushion.

So should you buy Caterpillar? Yes — for now, the pros outweigh the cons.

Tom Taulli runs the InvestorPlace blog IPO Playbook[6]. He is also the author of High-Profit IPO Strategies[7]All About Commodities[8] and All About Short Selling[9]. Follow him on Twitter at @ttaulli[10]. As of this writing, he did not hold a position in any of the aforementioned securities.

Endnotes:
  1. CAT: http://studio-5.financialcontent.com/investplace/quote?Symbol=CAT
  2. CNH: http://studio-5.financialcontent.com/investplace/quote?Symbol=CNH
  3. DE: http://studio-5.financialcontent.com/investplace/quote?Symbol=DE
  4. JOY: http://studio-5.financialcontent.com/investplace/quote?Symbol=JOY
  5. 50% of operating profits come from this segment: http://blogs.barrons.com/focusonfunds/2013/07/17/caterpillar-slips-chanos-is-short-as-commodity-super-cycle-comes-to-an-end/?mod=BOLBlog
  6. IPO Playbook: http://investorplace.com/ipo-playbook/
  7. High-Profit IPO Strategies: http://goo.gl/TXQsz
  8. All About Commodities: http://goo.gl/FfP8R
  9. All About Short Selling: http://goo.gl/t5Jzb
  10. @ttaulli: https://twitter.com/ttaulli

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