Caterpillar (CAT, Financial) witnessed a challenging 2015 from a stock price perspective, and the stock finally bottomed out at $57.9 on Jan. 26. Since that date, the stock has trended higher by 32% to current levels of $76.4.
After a meaningful rally from this year's lows, is the stock worth considering at current levels or can investors wait for some correction?
Some economic data points make the case that Caterpillar can be avoided at current levels and a correction would be a good opportunity to buy the stock.
Starting with China, the manufacturing PMI for May was 50.1, unchanged from April. Further, China’s nonmanufacturing PMI for May was 53.1, which was slightly lower than 53.5 for April. China’s manufacturing and nonmanufacturing PMI clearly show that there is no indication of reversal in growth and as China’s growth remains sluggish, I expect Caterpillar’s growth to disappoint in 2016 and potentially in 2017. In other words, the company’s biggest growth driver remains muted; if broad markets correct, Caterpillar is likely to trend lower.
The jobs report for May for the U.S. is another reason to be cautious on Caterpillar. For May, only 38,000 jobs were added, and this is a clear indication of slowing economic activity in the U.S. The global economy is trending lower, and this concern will impact broad markets as well as companies catering to the industrial sector like Caterpillar.
Therefore, the economic conditions will impact the industry, and that’s the reason to be bearish on Caterpillar for the foreseeable future. There are no negative triggers from a company specific perspective. The industry factors will dominate and will dictate the stock price trend in the coming quarters.
I would consider buying Caterpillar on any correction. The reasons to be bullish on the stock for the long term are as follows:
- Even in challenging times, Caterpillar has maintained the current dividend payout of $3.08 per share that translates into dividend yield of 4.25% at current stock price. Caterpillar is a quality stock for dividend investors and is likely to remain a dividend aristocrat.
- Oil prices have been trending higher and if oil sustains at higher levels, Caterpillar can witness renewed activity from the oil and gas exploration business. While strong recovery in the energy industry is not coming any time soon, oil trending higher is likely to ensure that sales from the segment do not continue to slide.
- The Indian economy grew at 7.9% for the last quarter and the country is likely to be a major growth driver for the global economy in the coming decade. If China’s growth stabilizes and India’s growth accelerates, Caterpillar’s sales are likely to gain traction from these two major economies.
Considering these factors, there are strong reasons to be positive on Caterpillar for the long term. In addition to robust dividends, the company has been creating value for shareholders through share buybacks, and buybacks are likely to sustain in the coming quarters.
However, a 32% rally from 2016 lows implies that the stock has limited juice in the current rally and economic concerns can take broad markets lower. Therefore, fresh exposure at current levels can be avoided and investors who are sitting on profits can consider partial or complete profit booking and re-entry at lower levels.
Disclosure: No positions in the stock.
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