Before the markets opened on Jan. 29, construction machinery and equipment giant Caterpillar Inc. (CAT, Financial) reported earnings results for the fourth quarter of 2020. While the numbers were down significantly from a year ago, they did beat analyst estimates, indicating things may not be as bad for the company as Wall Street previously feared.
However, the stock also trades at a higher valuation than it did at the end of 2019 as investors bet on widespread economic recovery and more heavy construction projects in the near future. The stock was only down about 1% during the course of Friday's trading despite the report of year-over-year earnings and revenue declines. Does Caterpillar have room left to run as the global economy recovers and more large-scale construction projects resume, or is such a future already priced in?
Earnings overview
In full-year 2020, Caterpillar recorded adjusted earnings per share of $6.56 compared to $11.40 in 2019, while revenue came in at $41.7 billion, down 22% compared with $53.8 billion in the previous year. The declines were fueled by lower end-user demand and by dealers reducing their inventories by $2.9 billion (often as part of cost-cutting measures). The operating profit margin was 10.9% for 2020, compared with 15.4% for 2019.
For the 2020 fourth quarter, the company brought in GAAP earnings of $1.42 per share compared to $1.97 in the prior-year quarter, while adjusted earnings were $2.12 compared to $2.71 in the fourth quarter of 2019. Revenue was $11.23 billion, a 15% decrease from $13.1 billion in the same period last year. Analysts had been expecting adjusted earnings of $1.46 per share and revenue of $10.93 billion.
Caterpillar attributed the earnings surprise primarily to strong operational performance and a lower effective tax rate, courtesy of a higher percentage of profits coming from the Asia-Pacific and Europe, Africa and Middle East regions.
Sales volume was down for all three primary segments during the quarter, with resource industries down 9%, construction industries down 10% and energy and transportation down 19%. The loss in sales was partially offset by lower manufacturing costs and selling, general and administrative expenses.
By region, consolidated revenues were down 21% in North America, 9% in Latin America, 8% in Asia-Pacific and 11% in the EAME area.
In terms of returning cash to shareholders, Caterpillar paid out $2.24 billion in dividends during 2020 and repurchased $1.13 billion worth of common stock. As of the year's end, cash and equivalents stood at $9.36 billion. Long-term debt due within a year stood at $9.14 billion, while long-term debt with a time horizon longer than a year stood at $25.99 billion.
Looking forward
Caterpillar and other heavy construction companies often serve as a good reference point for the global economy, as their sales tend to increase when governments are spending more on infrastructure and when companies feel stable enough to put cash toward large-scale construction projects.
In his review of the fourth-quarter financial results, Chief Financial Officer Andrew Bonfield said the company saw sales volumes increase sequentially compared to the third quarter, with the exception of energy and transportation, and noted that the company expects to continue seeing sales volumes increase in 2021.
In the long term, the company's strategy for profitable growth includes more investments in services, connectivity and the development of new products.
Valuation
Caterpillar is a company which typically sees sales change according to global economic health, though it is most closely tied to its home markets in the U.S. and the rest of the North America region, from which it derives approximately 40% of its revenue.
On the one hand, the company is expected to benefit from global economic recovery in 2021. The January World Economic Outlook from the International Monetary Fund projects the global economy to grow 5.5% in 2021 before slowing down to 4.2% in 2022. China and other emerging economies (as determined by GDP comparisons) are expected to outpace developed markets in terms of growth, which Caterpillar has the potential to benefit from due to lower market penetration in emerging markets and favorable tax rates.
However, the stock is trading at a higher price than it did at the end of 2019, hitting an all-time high of $197.54 on Jan. 12 despite bringing in significantly reduced profits. At a price-earnings ratio of 30.43, it is trading higher than the construction industry's historical median valuation of 20.32 and its own historical median valuation of 16.21.
Analysts expect the company to report revenue of $43.75 billion in 2021 and $48.88 billion in 2022, with earnings per share predicted to be $7.33 in 2021 and $9.82 in 2022. Based on the combination of the stock's historical valuation ratios, past returns and estimates of future growth, the GuruFocus Value chart rates Caterpillar as significantly overvalued.
Thus, those who invest in the stock at current levels could need to wait more than a couple of years for the value to catch up with the price paid, and capital gains would be dependent on the current valuation ratios holding strong or increasing. Caterpillar is a company that will continue to grow the global economy, but unfortunately for investors, that slow but steady growth would have a hard time catching up with the current price, with a reversion to the mean being a real concern in the meantime.
Disclosure: Author owns no shares in any of the stocks mentioned. The mention of stocks in this article does not at any point constitute an investment recommendation. Investors should always conduct their own careful research and/or consult registered investment advisors before taking action in the stock market.
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