Bill Nygren (Trades, Portfolio) is portfolio manager of The Oakmark Fund, The Oakmark Select Fund and the Oakmark Global Select Fund. He has an M.S. in finance from the University of Wisconsin-Madison and a B.S. in accounting from the University of Minnesota.
Bill Nygren and his partners are value investors, and they invest in companies that they believe trade at a substantial discount to what they consider to be the true business value. They believe that, over time, the price of a stock will rise to reflect the value of the underlying company. In evaluating potential investments, they focus on the following characteristics: A company's stock price and whether it is a significant discount to their estimate of underlying business value, free cash flows and intelligent investment of excess cash, and a high level of manager ownership. They look at each purchase as if they are buying a piece of a business and not just a stock certificate.
Bill initiated an investment in Caterpillar (CAT, Financial) in Q1, 2015 by buying 2.73 million shares of the company. Explaining his investment thesis on the company he wrote in his investor letter,
“Caterpillar is the world’s largest provider of construction equipment, diesel engines and industrial gas turbines. Caterpillar’s products earn high marks, as do the quality and scope of its dealer network, but the company has considerable exposure to the highly cyclical and currently depressed oil and gas and mining segments. With substantial pressure from weak energy spending and the negative impact of the strong U.S. dollar, Caterpillar’s 2015 earnings will likely be down considerably from 2014 and toward the bottom end of their cyclical range. We prefer to value cyclical businesses on their earnings potential throughout the cycle, and we think that Caterpillar’s mid-cycle earnings will be considerably higher than current levels. With the Caterpillar share price falling to multi-year lows, the business is now attractively valued at just 10x our forecast of mid-cycle earnings. When we combine this attractive valuation with a 3.4% dividend yield and a strong balance sheet, we find Caterpillar to be a compelling investment.”
Caterpillar’s shares are under pressure since the back half of 2014. The key culprit is the fall in oil prices that has impacted the company’s 2015 outlook. According to Caterpillar’s latest 2015 outlook, sales and revenues are expected to be about $50 billion in 2015, which is down about 9% from 2014 levels. Management expects continued weakness in commodity prices, particularly oil, copper, coal and iron ore. The sales will be hurt by several factors, but the single biggest factor is direct and indirect impacts from oil and gas price declines. About half of CAT's 2015 sales decline is expected to come from direct and indirect exposure to oil and gas. The other factors include decreases in mining and the stronger U.S. dollar, decreases in locomotive sales, lower China construction industry and industrial engines.
For the year management expect profit per share of $4.70 and excluding restructuring costs at $5.00. On the positive side, lower incentive compensation expense, improved variable margin, lower restructuring costs, positive currency effects and slightly improved price realization are expected to help the company’s profitability.
In a nutshell, 2015 is going to be a tough year for Caterpillar. However, this is already factored in the company’s stock price, and the big question now is whether the company’s 2015 guidance marks the bottom for the company. I believe the worst is already factored in the company’s updated guidance. Oil prices seem to be bottoming while the dollar is also stabilizing. Sell side analysts are expecting the company’s top line to remain flattish and its EPS to increase in FY2016.
Analysts at Baird recently upgraded the stock to outperform citing cyclical bottom in commodities markets. According to Baird analyst Mig Dobre, the decline in commodity prices over the last several years is similar to the 1980s bust, and anything worse is unlikely, given the significant stimulus from central banks around the world. He also said that Caterpillar’s stock typically bottoms before the actual bottom in the mining business and "waiting for confirmation from improvement in bookings could mean being late to the party."
Caterpillar is trading at a forward PE of 16.14 and has a forward annual dividend yield of 3.40%. I expect the company to be more aggressive in terms of buybacks and restructuring going forward. The company’s medium to long term prospects looks good. Long-term investors should look to buy this quality large cap stock cheap at current levels.
