When faced with a trade crisis and potential geopolitical strife, investors have two options. On the one hand, they can take up defensive positions in stocks that can weather a storm. On the other hand, they can pursue a more aggressive strategy, hunting for companies unfairly battered by the winds of international turmoil.
In this article, we will be addressing the latter strategy through a relatively narrow lens. Specifically, we will address one interesting, profitable and well managed company with significant business in – and thus exposure to – the Chinese market: Caterpillar Inc. (CAT, Financial).
With the trade war posturing still going on, it is well worth taking a look at each of these stocks. A skittish market could send Caterpillar into bargain territory, despite the fact it should be unduly harmed financially or operationally – even if the tough trade talk blows up into serious trade conflict. Value investors would be wise not to miss the opportunity if and when it presents itself.
Chinese-fueled growth
Caterpillar, the world’s leading maker of construction and mining equipment, has enjoyed tremendous growth opportunities thanks to the sustained Chinese construction and development boom. China’s hunger for growth has only been growing in recent years, and Caterpillar’s equipment has played a significant role in facilitating the country’s ambitious goals.
Caterpillar reported $45.5 billion in revenue in 2017, 21% of which came from the Asia Pacific market. While China is not broken out specifically, it is safe to say the region’s economic powerhouse is taking the lion’s share of Caterpillar’s regional business. That can be concluded based on the fact the company’s own reports state that half of the 23% growth in the Asia Pacific region came from China.
Exposed to trade trouble
Caterpillar is helping fuel China’s boom, but China is also a major player in Caterpillar’s own growth story. Restricted access to the Chinese market or punitive tariffs initiated as early salvoes of a trade war could threaten to dent Caterpillar’s future prospects. Fear of such an eventuality is likely to have a considerable impact on the company’s stock price, so long as the threat of a trade war – or even escalating tensions – remains on the table.
Specifically, it would not be surprising to see a pullback in Caterpillar shares in the event of threats of tariffs on heavy machinery or other products adjacent to its market interests. The stock has been on a tear for the past 12 months, so a pullback could well be in the cards if market conditions seem to shift.
Profiting from fear
Caterpillar is blessed with considerable market power within its niche. Specifically, it remains the world’s largest maker of construction and mining equipment. With about 20% of global market share, Caterpillar is hard to push around and is an essential supplier to many of the heavy industry businesses necessary to China’s economic engine. Thus, even in the event of trade conflict, Caterpillar’s position in China looks relatively secure.
From a trading perspective, a pullback based on fear of reprisal from China or slowing growth in Caterpillar’s regional business presents an interesting opportunity. A year ago, Caterpillar traded around $100 a share. Now, it has moved above $150. That rise has been fueled by internal company economies, as well as the continued health of the global economy.
Verdict
The world economy could take a hit in the event of a real trade war, of course, but in reality any skirmishes in practice are unlikely to upset the economic order too violently. There is always some risk of uncontrolled escalation, but we would not bet on that outcome – it is in no party’s interest.
But the fear of escalation can cause movements in stocks even if the follow-through is unlikely. And therein lies a potential play on Caterpillar: a pullback due to trade war fears could drop this stock back toward territory that might entice a host of value-oriented investors.
Disclosure: I/We own no stocks discussed in this article.
