Caterpillar: Does It Deserve the Goldman Downgrade?

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.

Parting Thoughts

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.

Comments

[don2m:]

Your assessment of Goldman's action is very informative and one which I totally agree. CAT will indeed lead any recovery news whenever it occurs 09,10 or whenever. The yield is worth waiting for at the moment and time will tell if they are slipping further into trouble with their financial unit. China and India are in my opinion going to be their salvation. The current relationship between China and CAT has been built over time by a good understanding by Jim Owens as to the almost guaranteed growth of China in good and bad times.
A graph showing an up trend even though slowly beats a graph showing down trend with no end in sight. CAT is a world class company for many reasons, a quality product being only one of them

2008 Dec 14 10:00 AM

[User 283977:]

Don2m's comment about their offering a world class product is right on. Goldman is underweighting the brand valuation of this company. On top of that, we have information on what the President Elect says he is going to do - sooner rather than latter.

I agree with the author, the downside risk looks low. As an added bonus, its current yield of about 4% means you get paid for waiting for the expected up-tick. I am long on CAT and FLR for the same reason.. an infrastructure play.

2008 Dec 14 11:18 AM

[RCA:]

Does anyone still give credence to (let alone make investment decisions on) analysts' opinions anymore?

2008 Dec 14 01:29 PM

[capital pains:]

The Goldman downgrade to "sell" was truly a jaw-dropper. Why not a downgrade to "hold" ? Preposterous tripe from the firm that is now the "gold standard" for missed calls, misguided investments and securitizations that buried the globe .... Goldman's plunge from $250 to $70 speaks volumes about this has-been firm and the "geniuses" who pontificate there.Not exactly the "best + brightest" conceit Goldman foistered on the investment world..This "emperor has no clothes" !
Judging by the pronounced thievery on Wall Street, one may only assume that the absurd downgrade to "sell" served the Goldman agenda somehow, ie; shorting, put buying, whatever the underhanded
agenda is..Unless there is going to be a run on plastic shovels and toy trucks, I can't figure out how the world's make-work infrastructure build-outs can exist without the great CAT ..Duh !!
I have owned CAT countless times for the past 10 years or so. I have seen the stock downgraded numerous times, only to rise to the top time
and again. Throw in the fact that the clown Cramer is also down on CAT and that's a sure indication that CAT is a winner !
Goldman threw a hurt into this stock temporarily. Just an unfortunate annoyance, albeit a costly one ..Goldman is so over..But, CAT will always be primo !!

2008 Dec 14 02:33 PM

[charles hopfl:]

Isn't it crazy when after a stock has had a long ride on the downside and has about bottomed out, that the rating agencies and brokers, (like Goldman, etc.) then wake up and all of a sudden decide that the stock should be down graded. Is this stupidity or a phony ploy to drive the stock lower since they have shorted it. It is probably both and this is what has allowed cynics to believe that the market is rigged, especially against the public.

2008 Dec 14 03:02 PM

[jepittman:]

Goldman has been alleged to have traded their own accounts against their client's. When Goldman speaks you just don't know whose position is being pumped for what purpose. Its best to ignore them.

2008 Dec 14 10:59 PM

[k45:]

CAT looks good to me, but I bought at 32 and 36. Good yield, solid, quality company, and it will eventually make money (already has for me). If Goldman is right, I'll probably buy some more.

2008 Dec 15 05:01 PM

[Marc Courtenay:]

Appreciate the author's insights. Word on the street is CAT might be getting into the alternative power business in a much bigger way starting next year. That would be a very smart move for the company and they could benefit from the infrastructure-Obama boom that is directly ahead.

2008 Dec 15 05:34 PM

[Stock Gambler:]

CAT has tightened down all expenses across their divisions - sorry to say includes layoff of many contract & specialty workers across the world and preparing for continued slowness in 2009. They are receiving orders but customers don't have the financing to put dates to them yet. Their dividend looks secure however, especially considering the comments made by their management that "they learned their lesson in the '80's about cutting/eliminating dividends". I am in at $32.88 and will go more if dips back to the range. And, charts are at least short-term bullish.

2008 Dec 15 05:49 PM