Caterpillar: Revving Up Growth

I have always been a big fan of  Caterpillar (CAT). It’s one of the best managed  global brands in the world. And if you’re looking for value, it doesn’t really get any better than this. The company has plenty of cash ($3.7 billion of free cash flow in 2007), solid operating margins and a stellar management team. This year marks the 6th straight year of record sales and revenues for CAT, and 2009 does not look too bad, despite a revision on its future earnings.

You want a company that can survive difficult times and benefit from an eventual emerging markets comeback? Caterpillar is part of this exclusive club.

CAT is also a stock that was severely punished by the recent market meltdown. I don’t think it was justified, given the company’s recent performance, robust balance sheet,  and long term outlook. Last week, Caterpillar reported third-quarter revenues of $774 million--an increase of $16 million, or 2 percent compared with Q3 2007 (see conference call transcript). This was achieved under a deteriorating business environment in the developed world, but because the company is so well diversified and so well managed, it was able to offset the decline in activity here in the U.S. and Europe.

Fears of a global recession make CAT too risky for some investors who expect a big slowdown in some of CAT’s core markets. I think that they are wrong. Yes, the mining and energy sectors will take a hit, but it won’t be as severe in some regions. China, India and Africa will continue to drive growth. Furthermore, infrastructure projects in the rest of the developing world will continue despite the economic downturn, particularly those being financed by governments in order to to create jobs. You also have to consider that machinery ages and new parts are needed all the time--roads and highways need to be repaired whether the economy is doing well or not.

Furthermore, CAT’s clean diesel and natural gas engines are in high demand around the world, which can offset the drop in truck sales and other heavy equipment. John Kearny of Morningstar recenty wrote that even under the most pessimistic of scenarios, Caterpillar was worth no less than $54 a share. I think that analysis is right.

Disclosure: I own shares of Caterpillar.

Comments

[Larry House:]

I want to see how CAT is going to rev up growth in a slowing world-wide economy. This should be good. I'm sorry, Max, but just saying "China, India, and Africa will continue to drive growth" just don't make it so.

2008 Oct 30 05:21 PM

[Max Zeledon:]

china and India certainly won't bail out the global economy, but that does not mean they won't continue to grow while we slug through this mess. I go by what experts are saying--keeping in mind that the data is not entirely accurate. But here is the evidence: China's economy expanded 11.9% last year--a pace that has obviously slowed down this year. Nevertheless, the IMF thinks the Chinese economy will grow 9.7% in 2008 and 9.3% next year. That's good enough for me even if we're off by two percentage points.

Both China and India are prepared to ramp up government spending when it comes to infrastructure in order to boost their domestic economies. China has $1.8 trillion in foreign exchange reserves, so yes I expect growth to continue because they have the liquidity to support state-sponsored projects.

The dynamics in the emerging markets are much different than in the developed world. The emerging economies will have much more government support--particularly China and India because they need the infrastructure. But that's my belief and I'm willing to take the risk.

2008 Oct 30 08:14 PM

[Larry House:]

I too see China as one of the best hopes for growth, and I am investing in China. I see that as a better bet than CAT right now, and it may take years for China investments to do well.

2008 Oct 30 11:04 PM