The Construction & Farm Machinery & Heavy Trucks face the uncertainty of farming yields and crop prices. I see this sector with a strong demand in the next years due to an increase of construction projects in emerging markets, as well as government stimulus to develop urbanization in countries like China. So let's take a look at two companies in this industry and see which one is doing better and become the better invest.
Caterpillar Inc. (NYSE:CAT) is the world’s largest supplier of heavy machinery. Despite that it holds a dominant share in the U.S., the company is also a leading exporter (more than half of its 2012 sales). The company paid $8.8 billion in 2011 for acquiring Bucyrus, the mining equipment manufacturer, searching for synergies (over $500 million annually by 2015), the capture of aftermarket parts and services business, and cost savings in the areas of purchasing and engineering. A substantial portion of its operating profits are from the mining end market. In this sector the company benefits from an oligopoly-style market structure (high barriers to entry and pricing power).
Outside the U.S.
Emerging markets in China, India, Africa and the Middle East, are showing positives, and it is expected that government stimulus spending and industrialization that would lead to further urbanization, will contribute to revive demand for CAT's products.
Because of substantial capacity increases in Latin America, where positive growth has been achieved, the company plans to invest in order to increase production of construction machinery. The outlook for the region remains strong, especially when someone thinks for example in Brazil, where FIFA World Cup is next year and the Olympic Games in 2016.
But not all is good news. The company also faces greater competition in international markets: The Japan-based company Komatsu has led in international service expansion as well. Remember that Caterpillar has a good presence in Japan, where it reported a currency benefit in the first half due to a weak Japanese yen that provide a cost benefit.
In terms of valuation, the stock sells at a trailing P/E of 13.3x, trading at a discount compared to the industry average of 15.7x, representing a discount of 15.3%. Analysts’ expectations imply a forward P/E of 11.68. At that P/E it seems cheaper compared to the industry average.
Cash Is King
Now let´s see another option for investing in this sector: Deere & Company (NYSE:DE). The company is investing hard (has launched several new tractor products) to increase its market share in Brazil because the value of agricultural production is expected to rise. Deere expects its agriculture and turf sales to grow 20% in South America.
Looking at the financials, the company has a strong balance sheet as well as good cash that allow the company to pay out earnings to current shareholders. In 2013, Deere increased its dividend to $0.51 per share and plans to increase its dividend payout ratio on an average of 25% to 35%. Also, the company repurchased shares during the third quarter, to a total of $712 million of shares in fiscal 2013.
Its P/E multiple, on a trailing-12 month basis, is 9.7 and the forward P/E multiple is 10.32. A company characteristic (as we see before) is that demonstrate its commitment to return cash to investor in the form of dividends. The current dividend yield is 2.41%, which is quite good to protect the purchasing power of consumers.
Finally, I always like to see the evolution of one of the most important financial ratios applying to stockholders, the best measure of performance for a firm's management: the return on equity.
|Company||ROE||Compared to Industry Mean (=8.1)|
|Deere & Company||44.8||Above|
Looking at the table we can see that both companies show extremely good ratios.
Despite the effects of changes in development demand, weak overseas growth, commodity prices or government spending on infrastructure, which could lead to a slowdown in revenues in both companies, I see Caterpillar better positioned than Deere.
Hedge fund gurus like Joel Greenblatt and Murray Stahl added this stock to their portfolios, and I would advise fundamental investors to consider adding this stock to their long-term portfolios. The fact that Bill Gates holds a large position in the company provides me with an extra quota of optimism.
Disclosure: Victor Selva holds no position in any stocks mentioned.