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Why Caterpillar Inc. (CAT) Can Lead the Dow Rally in 2017

After being the subject of negative trends in the past few years, Caterpillar Inc. (CAT) emerged as the best performing component of the Dow Jones Industrial Average for 2016.

Caterpillar stock’s 36.46% gain through the year made it the clear winner, trumping gains of UnitedHealth Group Inc (UNH), Chevron Corporation (CVX), Goldman Sachs Group Inc (GS) and JPMorgan Chase & Co. (JPM). They witnessed gains of 36.04%, 31%, 32.8% and 30.7%, respectively.

Meanwhile, the Dow rose 13.42% through the year to close at 19,762.6 on Dec 30, 2016, close to the 20,000 milestone.

Further, Caterpillar’s share price has also outperformed the Zacks categorized Manufacturing-Construction and Mining subindustry, which has witnessed a gain of 36.2% in 2016.

Caterpillar’s financial performance was not worth writing home about in 2016 as the mining and construction equipment behemoth continues to reel under lower end-user demand attributable to continued weak commodity prices globally and economic weakness in many developing countries.

Revenues for the nine months ended Sep 30, 2016, were $28.963 billion, a 20% plunge on a year-over-year basis, due to declines in Energy & Transportation, Construction Industries and Resource Industries. Earnings were at $2.58 per share for the period, a 43% drop from $4.54 in the prior-year comparable period.

Its evident that the price performance was not driven by Caterpillar’s financial performance.

So what led to the surge?

Trump & Thriftiness Led the Caterpillar Price Surge in 2016

Caterpillar’s share price has benefitted from the victory of Donald Trump as investors expect his plans of big spending in infrastructure, and easing regulations for oil and coal exploration would aid boost the company’s revenues. Further, investors appreciate Caterpillar’s determined efforts to cut costs that will lead to margin expansion as revenues improve under President Trump.

Caterpillar’s goal is to reduce costs such that the decline in operating profit is no more than 25–30% of the decline in sales and revenues. In Sep 2015, the company commenced significant restructuring initiative, with actions expected through 2018. Once fully implemented, it will lower its annual operating costs by about $1.5 billion.

So far, Caterpillar has surpassed its targets by announcing the closure, consolidation or contemplated closure of nearly 30 facilities globally and reduced the global workforce by about 14,000. In the past year, it has taken additional restructuring actions that include ending production of on highway vocational trucks and track drills.

Additionally, the company recently announced its exit from the room and pillar business.

But will the momentum sustain in 2017?

Trump’s pro-growth economic policies of increased government spending, reduced regulations, and increased tax cuts are likely to boost economic growth and create more jobs. Consequently, the companies are likely to have excess cash, fuelling earnings growth.

Further, the Dow is expected to continue its upward trajectory this year. Caterpillar will also follow suit given its focus on aggressive restructuring, focus on customers and on the future growth by continuing to invest in digital capabilities, connecting assets and job sites along with developing the next generation of more productive and efficient products.

The recent rebound in commodities instils confidence that healthier economic conditions across the globe could finally spur the long-awaited turnaround for the company. There exists key opportunities in the precious metals sector as miners resume projects that were placed in the back burner and expand current operations owing to the recent rally in metal prices.

Further, the Architecture Billings Index, which is considered a leading indicator of U.S. non-residential construction, has remained above 50 in the recent months, signalling robust conditions ahead for the construction industry. As per Dodge Data & Analytics, total U.S. construction starts for 2017 will advance 5% to $713 billion, following gains of 11% in 2015 and an estimated 1% in 2016. The construction industry has now entered a more mature phase of its expansion and construction spending can be anticipated to witness moderate gains through 2017 and beyond.

Zacks Rank & Key Picks

Caterpillar currently carries a Zacks Rank #3 (Hold). Some better ranked stocks in the same space include Altra Industrial Motion Corp (AIMC), Actuant Corporation (ATU) and Deere & Company (DE).

Altra Industrial Motion has a positive average earnings surprise of 8.06% in the last four quarters. It has witnessed a 1% increase in its earnings estimates in the past 30 days. It currently carries a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Actuant generated a positive average earnings surprise of 11.47% in the trailing four quarters. Its earnings estimates have gone up 8% in the last 30 days.

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Deere’s estimates have also moved north 15% over the last 60 days. The company has delivered an average positive earnings surprise of 15% over the last 4 quarters. Both Actuant and Deere carry a Zacks Rank #1.
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JPMORGAN CHASE (JPM): Free Stock Analysis Report

GOLDMAN SACHS (GS): Free Stock Analysis Report

ACTUANT CORP (ATU): Free Stock Analysis Report

CATERPILLAR INC (CAT): Free Stock Analysis Report

DEERE & CO (DE): Free Stock Analysis Report

ALTRA INDUS MOT (AIMC): Free Stock Analysis Report

UNITEDHEALTH GP (UNH): Free Stock Analysis Report

CHEVRON CORP (CVX): Free Stock Analysis Report

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