Cyclicality is a fact of life for companies like Caterpillar (CAT), but the depth of the current downturn — and the unusual uncertainty of when it will lift — suggests that CAT stock is still too pricey to be a value pick.
In other words, Caterpillar stock has farther to fall, even though it’s already off more than 20% year-to-date and not far from a five-year low notched in early September. The valuation just doesn’t sufficiently reflect how bad future profits are going to be for Caterpillar.
Caterpillar earnings missed Wall Street estimates, and the company cut its forecast. That’s a recipe for a selloff, but investors can’t be too surprised. Slower economic growth in China — as well as recession in Russia and Brazil — are clobbering prices for everything from iron ore to copper.
Naturally, mining companies have no interest in making big capital expenditures on CAT equipment in such an environment.
That would be hard enough to deal with, but the rout in prices for crude oil is also hammering CAT’s energy and transportation segment.
The hit from oil and gas is particularly cruel. Most U.S. multinationals are getting a much-needed boost from the improving domestic economy — but not CAT.
CAT is cutting costs as fast as it can — last month it announced job cuts of 10,000 — but not fast enough to keep up with the deterioration in its sales. As such, both the bottom and top lines are expected to continue declining through the end of next year, at least.
Caterpillar Earnings Undercut CAT Valuation
As bad as business is, investors are right to be surprised that CAT missed on earnings and slashed its forecast because the company has done a pretty good job of managing expectations.
Before today, Caterpillar earnings exceeded Street forecasts for two quarters in a row.
That said, the Caterpillar earnings report did benefit from excellent timing. Caterpillar stock rose more than 2% in the first hour of trading on the heels of a more than 200-point gain for the Dow Jones Industrial Average, of which it is a component.
It’s hard to see how that can last in light of CAT stock’s earnings and forecast. For the most recent quarter, Caterpillar net income came to $368 million, or 62 cents a share, down from $1.02 billion, or $1.63 a share diluted, a year ago.
After excluding restructuring costs, earnings were 75 cents a share. Analysts were looking for earnings of 78 cents a share, according to a survey by Thomson Reuters.
Revenue likewise missed expectations. The top line fell to $11 billion from $13.5 billion year-over-year. The Street forecast stood at $11.25 billion.
Worse yet, CAT cut its forecast. For fiscal 2015, Caterpillar now projects adjusted earnings of $4.60 a share, down from a prior outlook of $5 a share.
Bottom Line
CAT is being battered by forces beyond its control, and there’s no telling when the storm will subside. And yet, CAT stock still trades at a significant premium on a forward earnings basis. Shares currently go for more than 18 times projected earnings.
That’s more expensive than the broader market, despite analysts expectations for essentially no compound annual earnings growth over the next five years. It’s also much pricier than CAT’s own five-year average of just 14 times forward earnings.
There’s simply no reason to put new money to work in CAT stock at such levels. The valuation sets it up for sideways trading at best.
At some point, CAT stocks may become a buy on the dip, but it’s going to have to fall significantly before it’s too cheap to ignore.
As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.
