It looks as if we’ve dodged a bullet, and the U.S. economy will be able to avoid another deep slump. But tepid growth may be the best we can hope for in the foreseeable future. Yet beyond our borders, growth should prove more dynamic, especially in emerging market economies. As China, Vietnam, Indonesia and other neighbors transform into world-class economies, they’ll need to ensure that their infrastructures can handle a steady wave of growth. And they’re likely to continue consuming large amounts of oil, gas, and other commodities to build the highways, power plants, and other hallmarks of a modern economy.
I can think of no clearer way to play that trend than Caterpillar (NYSE:CAT), the global heavy machinery powerhouse. Caterpillar has steadily increased its exposure to the Asian economies over the last few years, and also stands primed to benefit from rebounding demand for excavation and mining equipment to pull all of the key commodities out of the ground.
Like many multi-nationals, Caterpillar has surely seen some tough times. Sales fell a hefty -37% in 2009 to $32.4 billion, the lowest level since 2004, and per-share profits fell nearly -75% to $1.43. That’s well below the $5 to $6 a share the company earned in the previous three years. Yet there is a clear silver lining: management has implemented a wide range of improvements to the business with an eye toward boosting profit margins. As a result, profits should be sharply higher in the next peak in the economic cycle.
For starters, the company is sharply reducing the number of parts used to build its various machines and engines. That has given Caterpillar pricing leverage with suppliers, as higher volumes of fewer parts yield price concessions. Moreover, the company has hired a range of external manufacturing managers from firms such as Toyota (NYSE:TM) and General Motors that bring expertise in terms of material handling, production de-bottlenecking and quality control. As a result, the company thinks it will save several hundred million dollars annually on warranty claims, labor productivity and transportation costs.
These steps are just getting underway, and any benefits are being masked by a still-weak global economy. Yet signs are emerging that the U.S. economy is no longer in freefall, and Asian economies are starting to heat up. Asia, in particular, bears close scrutiny. Analysts at Smith Barney believe that the Asian region will see $700 billion in infrastructure spending over each of the next five years. That’s up from $370 billion in each of the last two years. They and others note that Caterpillar’s exposure to China is especially appealing.
With the exception of some especially bullish and bearish market phases, shares have traditionally traded for around 15 times profits. Assuming shares only trade up to around 12 times peak cycle profits of $8 a share, then the stock could well rise close to the $100 mark. That’s roughly 65% above current levels. It will take several years for that investment thesis to be realized, but Caterpillar clearly stands out as a platform for the global economic rebound – especially in Asia and in commodities.
-- David Sterman