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.
Acquisitions and international markets
The business is divided into several segments: Construction Industries (33% of revenues), Resource Industries (24%), Power Systems (36%), Financial Products (5%) and Other (2%). Caterpillar is one of the largest manufacturers and controls about one-fifth of the global new construction equipment market.
Acquisitions have helped the company. In 2005, it acquired SEM, a low-end Chinese competitor with relatively good prospects. In 2011, it acquired Bucyrus with the expectation that it will produce synergies of over $500 million annually by 2015.
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.
It still faces a strong competition in international markets, where the Japan-based company Komatsu has led in international service expansion as well. Both companies hold nearly 50% worldwide market share. In China, the company has a 10% market share position, but new competition from manufacturers would be a challenge.
Revenues, margins and profitability
Since the same quarter a year ago, revenues increased by 0.93%. This growth seems to have helped boost the earnings per share. EPS increased by 12.4% in the most recent quarter compared to the same quarter a year ago ($1.63 vs $1.45). During the past fiscal year, the company reported lower earnings of $5.75 versus $8.49 in the previous year. This year, Wall Street expects an improvement in earnings ($6.55 versus $5.75).
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 | 19.92 |
| DE | Deere & Co. | 32.80 |
| WBC | Wabco Holdings Inc. | 61.59 |
| Ă‚ | Industry Mean | 8.62 |
The company has a current ratio of 19.91% which is lower than the one exhibit by Deere (DE, Financial) but higher than 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, Wabco (WBC, 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.
Relative Valuation
In terms of valuation, the stock sells at a trailing P/E of 16.5x, trading at a discount compared to an average of 22.1x for the industry. To use another metric, its price-to-book ratio of 3.3x indicates a premium versus the industry average of 1.83x while the price-to-sales ratio of 1.2x is above the industry average of 1.03x. The first metric indicates 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 $20.709, that is a 15.7% compound annual growth rate (CAGR).
Final comment
This industry faces the uncertainty of farming yields and commodities (crop) prices. Although it still faces competition in China, government spending will continue to benefit Caterpillar´s products.
We believe that the business prospects look challenging and exposed to commodity prices. 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.
Hedge fund guru John Hussman (Trades, Portfolio) and Manning & Napier Advisors, Inc. 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
