Caterpillar (CAT) is one of the world's largest industrial goods producers with annual revenues of approximately $60 billion. The company makes money by selling capital goods to the construction, power, oil/gas, railway and mining sectors. The company also has a small financing division which helps in promoting product sales through vendor financing. While we think that Caterpillar has a great brand and significant market share in capital goods, we see a number of risks for the stock. In our view, the market is not discounting many of these growing risks and CAT faces both long-term and short-term threats. We see little reason to hold CAT, as the company does not give high enough dividends yield and has high stock price volatility as well.
Why we would not buy CAT
- Not a good Dividend Investment - CAT gives a dividend yield of ~2.5% which is not high enough in our view. There are many other safer stocks with a higher dividend yield. We think companies like Microsoft (MSFT), Dominion (D) and HP (HPQ) would be better bets as a dividend investment than CAT. The company's dividends also fell twice in the last decade due to the global economic slowdown.
- Valuation is not Cheap - CAT trades at more or less in line with the industry average. The P/S of 1x and P/E (TTM) of 10x is almost the same as that of the rest of the industry. The P/B ratio at 3.6x is slightly higher than the industry average at 2.8x.
- Management has messed up in China - Caterpillar revealed that it is taking a massive non-cash write-down on the recent acquisition of a Chinese producer of coal machinery. According to the company ERA managers had been systematically fudging the books for the last several years. With Chinese companies being in the media headlines for accounting fraud, you would have thought that CAT management would have been extra careful. But they have been found to be negligent on their due diligence. This reminds one of HP's massive blunder with the Autonomy acquisition. CAT has missed the bus in China with only 3% of its revenues coming from the world's 2nd largest economy. There are other big and low cost heavy equipment suppliers which have captured the market. It remains to be seen whether CAT can grow in China where domestic suppliers are favored over foreign ones.
- Levered to a Global Economic slowdown - Like Cummins (CMI) and other industrial goods companies, CAT is levered to the global economic growth cycle. The world is moving towards a lower growth trajectory despite some temporary recovery signs in US and China. The massive global imbalances and debt problems have not gone away and they will continue to act as a strong tailwind.
- Competitive Pressures - CAT is known around the world for its reliable and high-quality industrial machinery; however, the company faces strong competitive threats from companies such as Sany Heavy Industry, Zoomlion Heavy Industry and Komatsu. The Chinese companies are especially dangerous given the massive government and bank backing. They use lower costs and vendor financing cleverly to win market share. The advantages of quality and technology have proven futile in the face of such strategies. The telecom equipment market is an example of how Huawei and ZTE came from nowhere to beat the hell out of Western leaders like Alcatel-Lucent (ALU) and Ericsson (ERIC).
Strong International operations - CAT gets a large percentage of its revenues from Asia and Latin America which has fueled its overall growth in the last 2-3 years. The declining revenues from Europe have been more than offset by the emerging market growth. This international diversification is a strong point for Caterpillar.
CAT has climbed up sharply by ~15% in the last 1 month to trade near the $100 mark which is just 15% below its all time peak of $115. The company has given a loss of ~5% over the last one year. The stock is not for the fainthearted as CAT saw a drastic drop during the Lehman crisis falling to ~$24 in March 2009 when the S&P 500 touched 666. If the world sees another crisis, CAT will be the last stock you would want to hold in your portfolio.
Caterpillar is the biggest heavy industrial equipment maker in the world; however, we see no reason to buy its stock. The company's growth prospects going forward are not too great and it does not make for a good value/dividend investment. In addition, the company faces risks from a global economic slowdown and big Chinese companies expanding into international markets. The company's management has slipped badly in not identifying a big accounting problem with its recent Chinese acquisition. We see little prospects of upside with significant risks of a big downside going forward. The recent rally in the stock has made the investment case in the stock even weaker. We would sell CAT to look for better prospects in the stock market.