Caterpillar Inc. (CAT, Financial) is an American corporation that has been a key player in the global construction and mining equipment market for many decades.
Thesis
Although Caterpillar's business is highly exposed to cyclical industries and has been primarily impacted by the Covid-19 pandemic, the company has demonstrated financial strength and the ability to navigate economic fluctuations in various parts of the world effectively.
Caterpillar is a blue-chip company with growing revenue and operating income, a relatively low net debt-to-Ebitda ratio and, just as important, its management has consistently raised its dividend for 28 years, making it an attractive asset for long-term investors.
Author's elaboration, based on GuruFocus and Seeking Alpha data.
Caterpillar has a strong balance sheet with significant cash reserves and a record return on equity of 51.58%. Moreover, this emphasizes Jim Umpleby's ability to lead a company successfully in a competitive environment and also indicates the effectiveness of the implemented research and development and merger and acquisitions policies aimed at finding new market opportunities.
Author's elaboration, based on GuruFocus data.
We also expect that tightening carbon regulations and the adoption of the Infrastructure Investment and Jobs Act and the Inflation Reduction Act will create the necessary preconditions for maintaining high demand for Caterpillar services and equipment.
The order backlog stood at $28.1 billion at the end of September, which, given supply chain improvements in recent quarters, will allow the company's management to control its resources more flexibly and help improve its margins. In addition, having a solid backlog strengthens the company's reputation in the market and also helps attract new customers, which is an essential factor ahead of the expected interest rate cuts by the Federal Reserve in 2024.
In addition, thanks to the Ukraine-Russia war, Caterpillar is actively involved in constructing liquefied natural gas terminals and modernizing oil refineries in the European Union. At the same time, given the low likelihood of peace negotiations between President Volodymyr Zelensky and President Vladimir Putin, as well as the desire of European leaders to abandon the use of fossil fuels coming from Russia, this will contribute to increased sales of the company's products, especially industrial pumps, electric drive motors for gas compression and land drilling generator sets.
On the other hand, we highlight several key factors due to the influence of which we begin Caterpillar's analytical coverage with a market perform rating for the next 12 months.
Our first concern is that the company's dividend yield is 1.77%, which is only slightly higher than the industrial sector average. Moreover, due to consumer inflation remaining above 3% in the U.S., Caterpillar does not provide sufficient protection against it. As a result, many conservative investors will consider other assets from the industrial sector that offer higher dividend yields.
Secondly, Caterpillar is trading at a trailing 12-month price-sales ratio of 2.20, which is 57.97% higher than the sector average and, just as importantly, 14.35% higher than the average over the past five years. This increased multiplier may indicate that Mr. Market has already considered the prospects for developing its business in the price of Caterpillar shares.
Besides, taking into account the technical analysis that will be presented later in the discussuion, we believe that in the short term, the company's share price will begin to correct to a strong support zone located in the range of $268 to $270 per share, where eventually we plan to open a long position.
The financial position of Caterpillar and its prospects
Caterpillar's revenue for the third quarter of 2023 was $16.81 billion, exceeding our expectations by about $110 million, but more importantly, it increased by 12.1% year over year.
Author's elaboration, based on GuruFocus data.
The first key contributor to the company's revenue growth is its Construction Industries segment. Its total sales were approximately $7 billion for the three months ended Sept. 30, an increase of 11.5% year over year, driven by the strengthening of the euro against the U.S. dollar, higher equipment prices in North America and expanding the company's product range. At the same time, these factors partially mitigated the decline in the sales volume of Caterpillar's products in two regions, Asia-Pacific and Latin America.
Author's elaboration, based on quarterly securities reports.
The second contributor, playing a key role in improving the company's financial position, was the Energy & Transportation segment, focused on serving clients in such industries as oil and gas, energy, marine and railway. Its revenue was approximately $6.86 billion for the third quarter, an increase of 10.9% year over year due to several factors. These factors that we highlight are the increase in prices of the company's equipment and the increase in sales of reciprocating engines, generator sets, turbines and electrified power units for oil and gas companies, mainly engaged in the construction of LNG terminals in Europe and the modernization of oil refineries in the United States.
Author's elaboration, based on quarterly securities reports.
The world's leading mining equipment manufacturer is anticipated to release fourth-quarter 2023 financial results on Jan. 26, 2024. Caterpillar's revenue for the quarter is expected to be $16.75 billion to $17.64 billion, up 3.5% from analysts' expectations for the previous quarter.
However, according to our model, Caterpillar's total revenue will be above the median of this range and reach $17.32 billion. The company's revenue growth, both quarterly and year over year, will occur mainly due to the expected increase in spending on non-residential construction in the United States, increased prices for equipment used in the heavy and oil and gas industries, increased spending by shipping companies on the modernization of container vessels and increased infrastructure investments in China.
Created by author.
We expect the company's operating income margin to reach 20.7% in 2023. On the other hand, this financial metric will increase slightly to 22.2% by 2024, mainly due to an increase in the volume of both construction and civil engineering works in the world, an expansion of Caterpillar's product range, a decrease in the cost of raw materials and components necessary for the production of its equipment and the weakening of the dollar relative to foreign currencies.
The company's third-quarter non-GAAP earnings was $5.52 per share, up 39.7% year over year and, just as importantly, it beat analysts' consensus estimates in the last nine of 10 quarters.
On the other hand, Caterpillar's fourth-quarter earnings are expected to be in the range of $4.35 to $5.06, which is slightly lower than analysts' expectations for the previous quarter. Meanwhile, we anticipate this financial metric to be higher than this range and reach $5.25, including due to its management's use of a share repurchase program.
Author's elaboration, based on GuruFocus data.
At the end of September, the company's total debt was approximately $37.14 billion, remaining almost unchanged from previous years. On the other hand, due to Caterpillar's improved margins in recent quarters, its total debt/Ebitda ratio dropped below 3.
Author's elaboration, based on GuruFocus data.
Given the growing cash flow and the total cash and short-term investments exceeding $8 billion, we do not expect the company to have difficulty repaying its debentures and senior notes.
Author's elaboration, based on GuruFocus data.
Technical analysis
According to the Elliott Wave theory, we believe the impulse wave marked as 1-2-3-4-5 has been completed, and a corrective wave is currently forming to reach the support zone from $268 to $270. Additionally, the relative strength index on the daily chart is above 80, indicating Caterpillar stock is overbought. In addition, it should be noted there is an unclosed gap between $268 and $269.50. Such gaps attract the attention of investors and traders, as they are often considered potential levels to which Mr. Market will strive to return to close a given price difference.
Source: TradingView.
Conclusion
Caterpillar is a blue-chip company with a low net debt-to-Ebitda ratio, a high return on equity of 51.58% and growing revenue and operating income, thanks to adopting the Infrastructure Investment and Jobs Act and the Inflation Reduction Act. These and other factors described in the analysis make Caterpillar an attractive asset for long-term investors.
On the other hand, the dividend yield of the company continues to remain below U.S. consumer inflation, Caterpillar's trailing 12-month price-sales ratio is significantly higher than the sector average and, taking into account technical analysis, we expect its share price to correct to the support zone of $268 to $270 over the next two months.
We initiate our coverage of Caterpillar with a market perform rating for the next 12 months.
