Caterpillar (CAT, Financial) has been on a sustained decline, and the stock has corrected by 29% for the year. At various levels, Caterpillar looked like a good investment, but the support levels were broken, and the downside continued through 2015. Is Caterpillar a good investment for 2016?
Caterpillar is worth accumulating through 2016. The stock is likely to remain sideways or marginally lower during the year. However, for value investors and for dividend investors, the stock is worth holding.
Broadly, there are two factors that have contributed to revenue and profit decline for Caterpillar:
- China’s growth has remained sluggish, and the metals and mining industry slowdown has impacted the company’s sales.
- Oil and gas prices have declined, and the sales have also been impacted due to a weak energy sector.
On the China factor, the chart below gives the manufacturing PMI for November.
While the manufacturing sector remains in recession, the manufacturing PMI has stabilized at lower levels in the last few months. The manufacturing sector has bottomed out in all probability. Recovery in the manufacturing sector is unlikely in the near term, but bottoming out implies that Caterpillar stock has discounted the current growth rate.
Therefore, Caterpillar will decline further on “China growth factor” only if the economic slide deepens in 2016. In all probability, economic activity will continue at current levels.
The second factor that will impact the company’s earnings is oil, and few negatives are expected on that front. First, the oil export ban in the U.S. has been lifted, and that can potentially add to global supply excesses. Second, Iran is likely to commence oil sales in 2016, and that can depress prices further. However, it is important to note that Caterpillar is trading at FY16 PE of 18, and the concerns are largely discounted since both the factors have been in the news.
Caterpillar can be range bound; if the stock corrects by another 5% or 10%, it would be an excellent long-term buying opportunity. It is important to note that Caterpillar still offers a dividend payout of $3.08 per share.
Even with a relatively positive outlook on the stock, investors would be wise to buy only in small quantities now and increase their exposure to the stock only after 4Q15 results are released along with a revised guidance for 2016. Caterpillar has already issued an initial guidance of 5% lower sales in 2016 as compared to 2015, and that factor is discounted in the stock price.
From a financial perspective, there are no clear concerns for Caterpillar with the company still generating robust EBITDA and operating cash flows for healthy credit metrics to sustain. Therefore, industry specific factors need to improve; when that happens, Caterpillar will trend higher meaningfully from current levels.
Disclosure: No positions in the stock
