In this article let's take a look at Caterpillar Inc. (CAT, Financial), the world's largest producer of earthmoving equipment, and a big maker of electric power generators and engines used in petroleum markets, and mining equipment.
Overall Analysis
The company has reduced its inventory in the past quarters, while improving free cash flow. On the other hand, it still faces competition in China, and further mining equipment headwinds. Although the business prospects look challenging and taking into account that it remains leveraged to (high) commodity prices, I expect construction markets will improve this year as U.S. nonresidential spending improves. Although the demand is still below its historical peak, I really don't think it could lose its dominant position, so I believe its long term business will continue be profitable.
Acquisition of Mining Equipment Manufacturer
In 2011, Caterpillar acquired Bucyrus for $8.8 billion. The deal is expected to produce 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. As a matter of fact, a great portion of its operating profits are from the mining market, where results will probably continue to suffer in the near term.
Emerging Markets
Despite it holds a dominant share in the U.S.; it operates in every country around the world, with 61% of revenues derived outside of North America in 2013 and 75% of the firm's independent dealers were located outside of the U.S. Emerging markets such as China, India, Africa, and the Middle East, are key places to expand market share, also considering government stimulus spending and industrialization that would lead to further urbanization.
Caterpillar faces greater competition in international markets, the Japan-based company Komatsu has led in international service expansion as well. Both companies hold nearly 50% worldwide market share. Despite, both compete heavily it will not be a right decision to enter into a price war.
Revenues, Margins and Profitability
Since the same quarter one year prior, revenues increased by 0.2%. This growth seems to have helped boost the earnings per share. EPS increased by 10% in the most recent quarter compared to the same quarter a year ago. The net income increased by 4.8% when compared to the same quarter one year prior, going from $880 million to $922 million.
Finally, let´s compare the best measure of performance for a firm's management: the return on equity. The ROE is useful for comparing the profitability of a company to that of other firms in the same industry.
| Ticker | Company | ROE (%) |
| CAT | Caterpillar | 18.21 |
| DE | Deere & Co. | 44.79 |
| KMTUY | Komatsu | 10.59 |
| Industry Mean | 9.22 |
The company has a current ratio of 18.21% which is higher than the one exhibit by Komatsu Ltd. (KMTUY, Financial) and the industry mean. In general, analysts consider ROE ratios in the 15-20% range as representing attractive levels for investment, so for investors looking for a much more attractive ROE, Deere & Co. (DE, Financial) could be the option. It is very important to understand this metric before investing and it is important to look at the trend in ROE over time.
| ROE (%) | Ind.Avg | S&P 500 | |
| Q12014 | 18.86 | 18.74 | 14.43 |
| Q1 2013 | 27.22 | 20.83 | 13.15 |
| Q1 2012 | 35.33 | 24.79 | 14.26 |
Relative Valuation
In terms of valuation, the stock sells at a trailing P/E of 18.8x, trading at a discount compared to an average of 19.4x for the industry. To use another metric, its price-to-book ratio of 3.4x indicates a premium versus the industry average of 1.77x while the price-to-sales ratio of 1.3x is above the industry average of 0.92x. The first metric indicate that the stock is relatively undervalued and seems to be an attractive investment relative to its peers, because at that P/E it seems cheaper compared to the industry average.
As we can see in the next chart, the stock price has an interesting upward trend in the five-year period. The EPS are included because it often leads the stock price movement. If you had invested $10.000 five years ago, today you could have $40.718, that is a 32.4% compound annual growth rate (CAGR).
Final Comment
This industry faces the uncertainty of farming yields and commodities (crop) prices. As outlined in the article, global economic growth, an increase of construction projects in emerging markets, as well as government spending in countries like China, will continue benefit Caterpillar´s products.
Hedge fund gurus like Louis Moore Bacon (Trades, Portfolio), Jeremy Grantham (Trades, Portfolio), Joel Greenblatt (Trades, Portfolio), David Dreman (Trades, Portfolio), Steven Cohen (Trades, Portfolio), Ken Fisher (Trades, Portfolio), John Buckingham (Trades, Portfolio) and Murray Stahl (Trades, Portfolio) added this stock to their portfolios, and I would advise fundamental investors should consider adding this stock to their long-term portfolios.
Disclosure: Omar Venerio holds no position in any stocks mentioned
