Goldman has gone from from permabull (remember the $200 oil “super-spike” call from May?) to permabear in less than one year’s time. Earlier this year the call was for an average spot price for crude to be somewhere between $110 and $120 through 2011, while today the 2009 average spot was pegged at $45. In conjunction, Goldman is slashing estimates for commodities aluminum and copper, due to effects of reduced credit and demand worldwide.
Aluminum estimates now stand at $1,410 (down from $2310), while copper was reduced to $2950 from $5230.
Caterpillar Estimates Get the Axe
In line with these new estimates, Goldman downgraded Caterpillar (CAT) to a “sell” on Friday, with a new price target of $32. Goldman thinks that earnings won’t bottom out at the industrial manufacturer until the back half of 2010. EPS estimates for 2009 were reduced to $3.95 from $4.25, while 2010 estimates were cut to $2.85 from $3.65.
In essence, it sees Caterpillar lagging the overall economy in bottoming out (it sees a GDP trough in mid-2009) due to increased order cancellations, higher funding costs for $3-5 billion in debt rollovers next year, and reverberations from restricted credit around the globe.
Financial Unit Concerns
Goldman also sees higher losses coming in the Cat Financial unit, a prospect that also worried me earlier. While the loan losses from equipment financing are bound to tick up from here, Jim Owens has been adamant that there won’t be a blowup in the unit, and only $19 million in write-downs were recorded in the June quarter. We’ve got a long way to go before EPS would be meaningfully impacted on $4 billion of net income.
What to Make of It?
How much faith should we put behind these estimates? It’s a simple question, and borne out of no disrespect for Goldman. There are plenty of smart folks over there, and to say that it's been the toast of the industry for the past decade is quickly becoming a cliché. Goldman deserves credit for being early on the calls for rising oil in 2007, and for accepting recession conditions in the U.S. this spring.
That being said, it sure was swept up in the tight supply, global-growth fed theory of higher commodity prices this summer, and overshot way big and way late. Now it has set its 2009 estimates for aluminum and copper below the current spot prices ($1525 for aluminum on the LME in the front month, and $3232 for copper) which many (including myself), contend have oversold due to the same forces that drove prices up so high in the first place.
I see genuine risks in future equipment order cancellations, despite hearing from multiple executives that mining projects, etc. can still be profitable with prices at current levels. After all, there are miles of difference between “profitable” and profitable enough to shine through other options for capital. Caterpillar has outperformed the S&P 500 by about 11% since the company reported quarterly earnings in October and first told us it sees “flat” sales in 2009.
This was before our President-in-Waiting, and likely the reason for the outperformance of late, formally announced his infrastructure stimulus package.
I’ve been notably harsh on the sell-side community of late, but Goldman is still a bit intimidating. CAT shares were feeling the pinch from the news earlier today, but have rallied to even following the rebound in the broad markets. Given the fundamental backstops, I remain upbeat about Caterpillar’s place in the infrastructure rollout that while certainly on delay, seems destined to be completed. In most of the world, the government is responsible for infrastructure funding, and it's the only group willing to commit capital right now.
I see China continuing proactive paths to spur domestic growth and support commodity prices, which I believe will lead to a bottom on commodities. Did we hit it last week? I can’t say, but there’s too much vested interest in keeping prices from falling much further.
Regarding Goldman’s 2009 & 2010 estimates for CAT - I’ll be the first to admit that this particular economic recession, this crisis, has a much different shape and texture than any we’ve ever seen. The typical sectors that lead out of recession may not do so this time. But just for the record, industrials have typically been on the leading edge of business cycle blade.
Disclosure: Author does not hold positions in the companies mentioned; CAT shares are held in EpiphanyInvesting Secular Trends Portfolio.