The concept of diversity, when talking about a company’s activities, is a sword with two edges. When performance hits the fan, diversity can turn into an advantage as only one segment can be affected. However, diversification can curtail winnings during a moment of bonanza. In other words, a company with five segments will see a relative smaller impact in overall performance than a company with activities in a single segment, when that segment experiences an abnormal growth. Hence, with a recovering construction market in the US and declining prices for mined commodities, a comparison between Caterpillar (NYSE:CAT) and Terex (NYSE:TER) is all the more relevant.
Fronting the Headwinds
Caterpillar has been hit hard by declining commodity prices, as mining companies decided to delay or halt the purchase of new equipment. Also, miners delayed scheduled services and replaced original equipment parts for lower-cost options, i.e. generic. The compounded effect on overall performance manifested on a 10% year-over-year decline in revenues. A reality confronted through a block of cost reduction policies.
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- CAT 15-Year Financial Data
- The intrinsic value of CAT
- Peter Lynch Chart of CAT
The current upswing in the construction market in the USA and excavation market in China, offer Caterpillar opportunities to ameliorate previous loses. At the same time, cost-cutting policies continue to give good returns, while readjusting manufacturing capacity and allowing the firm to continue a repurchase program. Additionally, good news for shareholders is the increment in dividend quarterly payouts.
All the measures taken however, have not allowed Caterpillar to offset the 12% decline in sales during 2013. Losses have not been equally distributed and Asia (24%) has been the biggest looser, followed by North (2%) and Latin America (8%). Nonetheless, the losses hide a small recovery when compared to 2012. And a recovery in sales has been observed across the board for all segments.
Financially, Caterpillar has a back to stand the bad weather as margins remain wide and cash flow is strong. Trading at 16.8 times its trailing earnings, the stock carries an 18% discount to the industry average. And although gurus have not made moves during the 2014Q1, major shareholders Bill Gates (Trades, Portfolio) and Manning & Napier Advisors have incremented their position throughout 2013.
The Time to Collect Winnings
Terex is not a direct market competitor for Caterpillar. However, its activities are spread across five segments more or less in the same amount (25%). Also, its construction segment is only 13% while most segments focus on platform manufacturing. Nonetheless, all segments are deeply related to the construction industry. Additionally, the firm has divested the truck segment and continued the share repurchase program.
Especially promising for Terex are the prospects for the Aerial Work Platform segment. The rental side of the business has experienced a boom during the last few years, and the firm holds the necessary capital to serve the growing demand. On the other hand, the Materials Handling & Port Solutions segment has seen a rebound thanks to successful restructuring activities. However, efforts in this segment will not cease as backlog remains above 30%.
The divestiture of the truck segment indicates Terex’s intentions to focus on lifting and material handling solutions. In other words, the management is looking to reduce diversification. Only time will tell if the decision has been correct or not. As of today, the American Institute for Architects has announced a rebound in design services after three months of decline.
Currently Terex stands at a critical point. Revenue, net income and operating margins have risen in the last three years, but cash flow has not been able to sustain a positive trend. Hence, the challenge is to continue in the same path to consolidate its finance and reduce debt. Currently trading at 24.5 times its trailing earnings, the stock carries a 135% premium to the industry average. The gurus have taking notice of the fact and have been collecting winning since mid-2013 through position reductions.
The Entry Point
An intelligent investment is that which at the end of the day rewards the shareholder with a positive return over the initial investment. The high premium associated with Terex’s stock does not guarantee such scenario. Meanwhile, Caterpillar’s recovering performance offers an opportunity to make a profit in the long-term.
Disclosure: Patricio Kehoe holds no position in any of the mentioned stocks.