Caterpillar (CAT, Financial) stock has been in an uptrend for a large part of this fiscal year after bottoming out at $57.9 on Jan. 21. The stock is currently higher by 44% from year-to-date lows.
With the company reporting second quarter results, is the stock still worth buying at current levels or on correction? Based on the quarterly results and the guidance from the management, the broad conclusion is that Caterpillar has challenging times ahead, and it would be best to remain on the sidelines and consider exposure to the stock on correction.
While the stock continues to move higher, here are the key concerns that need to be highlighted and that can potentially translate into stock downside in the next three to six months.
The first point worth noting is that Caterpillar has revised sales outlook to $40 billion to $40.5 billion for the fiscal year from an earlier estimate of $40 billion $42 billion. The EPS outlook (excluding restructuring cost) has also been revised to $3.55 per share from an earlier estimate of $3.7 per share. Considering the current stock price of $83.5, Caterpillar trades at 23.5 times fiscal year PE, and this is expensive considering the view that the growth outlook for the company is likely to remain challenging.
The second point worth noting is that the management has clearly stated the company is not expecting an upturn in industries like mining, oil and gas and rail for the fiscal year. Recovery in all these industries will be very sluggish even in fiscal 2017. Therefore, EPS growth will remain sluggish potentially in fiscal 2017, and factors like Brexit and geopolitical tensions globally add to the worries.
Therefore, the key challenge remains from an industry perspective, and I expect U-Shaped recovery for all key industries for Caterpillar. In line with this view, it might be best to remain cautious on a stock that has already surged from oversold levels.
While I hold this view for the near term, if the stock corrects by 15% from current levels, I see it as an excellent opportunity to accumulate for the medium to long term. The company specific factors that make Caterpillar attractive on correction are as follows:
- First, Caterpillar currently has a dividend payout of $3.08 per share that translates into dividend yield of 3.9%. The dividend is sustainable and Caterpillar will remain a quality dividend stock.
- Second, Caterpillar will continue to create incremental shareholder value through share buybacks and even with challenging economic conditions, the company’s operating cash flow remains robust for dividends and buybacks.
- Third, Caterpillar still has robust growth potential in emerging markets and once global GDP growth stabilizes, I expect strong revenue traction in emerging Asia, Latin America and emerging Africa.
Overall, these factors will ensure that Caterpillar remains a long-term value creator, but the near-term outlook is certainly bearish and a PE of 23 is expensive considering the economic outlook. Broad markets are trending higher, but earnings can dampen sentiments to some extent in the foreseeable future, and the stock can correct in line with broad markets.
Disclosure: No positions in the stock.
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