For those not familiar with Caterpillar, Inc. (CAT), they do not have travel far to see one of the company's many products. They can be seen daily working on a new construction project, laying new pavement on a highway, digging into the earth mining for precious metals, or out in a field planting or harvesting crops. On Monday, the machinery giant reported fourth-quarter earnings. The average estimate on the Street is for Caterpillar to deliver $16.12 billion in revenue with $1.69 in EPS. Caterpillar posted revenues of $16.075 billion with an EPS of $1.04.
This number was not as high as the Street had expected, but due to some improper goodwill accounting from a Chinese acquisition, the firm was forced to writedown $0.87 per share. If not for that writedown, EPS would have come in at $1.91, which would have beaten the Street's estimates. Caterpillar also gave guidance of $7-$9 per share, with revenue ranging from $60-$68 billion. This is a wide range, but Caterpillar believes that with all of uncertainty in the world today that it is a fair estimate.
Over the course of the last 12 months, Caterpillar stock has experienced a great deal of volatility. The stock started 2012 trading in the low $90 per share range, then shot up to $116 per share, dropped down to $78.25, and ended the year back in the mid-$90s. Looking at it from a year-over-year perspective, the stock at the beginning of 2012 was trading at $90 per share and now trades for $95 per share -- representing only a 5.55% rate of return year over year, regardless of the amount of volatility felt by shareholders.
As small of a return as 5.5% might sound 2012 was not a total bust of a year for Caterpillar shareholders. Caterpillar increased sales by 7% during the year, ending the year on $66 billion in revenue. Caterpillar also increased its dividend payout again this year from $1.84 to $2.04. This increase represented a 13% increase in payout. This increased payout still only represents 20% of the overall EPS, making the current yield and future increases very manageable and sustainable. Even among these positive events, the stock continued to struggle and for long-term holders.
When examining Caterpillar from a fundamental basis the company looks well positioned to capitalize on any resurgence in growth and spending. Revenue in the 2012 year came in at $65.875 billion which was a 10% increase compared to the year prior. Caterpillar generated a total 2012 EPS of $8.48, which was 15% above 2011 numbers and was a record for the company. The company has $5.88 billion in cash on hand and its stock has a current book value of $27.40 per share. With the stock currently trading at $97.50 per share, Caterpillar stock is currently trading for 11.50 times earnings. If we were to adjust back in the $0.87 writedown, the stock would then be trading for 10.46 times earnings.
Given a P/E of 11.50, Caterpillar, from a multiple standpoint, seems to be trading at a slight discount compared to its peers.
CNH Global (CNH)
Deere & Company (DE)
H&E Equipment (HEES)
Before we get too excited about the cheapness of Caterpillar, one thing that I think is always important to take into consideration before just going all in is to understand if there is a bigger underlying reason as to why Caterpillar is trading for such a low multiple. Since markets (for the most part) are always forward looking, P/E multiples can be brought down preemptively prior to the bad news actually hitting the wires. This is especially true with two companies that I happen to own now, Western Digital (WDC) and Intel (INTL). Both companies currently trade for low multiples (Western Digital at 5.83 and Intel at 9.83), but the market expects year-over-year EPS numbers to start coming down due to perceived decreased PC demand. Being this is the case, the market has already discounted the stock price and factored in the decline in growth going forward.
Comparing the last several quarter's earnings numbers to the expectations for next quarter the street is expecting Caterpillar to report decreased sales next quarter by 5.80%. This translates to an average estimate in EPS for the first quarter of 2013 of $1.80. Compared to the same quarters the year prior these decreases represent a 25% overall decrease in projected sales. The chart below outlines the past five quarters and the average estimate for the March 2013 quarter.
* Average EPS estimates for the quarter.
Looking at the trending for Caterpillar's earnings I can't say that it looks extremely encouraging, especially considering that there was virtually a zero EPS growth rate between June and September this last year. Additionally, given the downbeat news that Caterpillar delivered earlier this month, reporting that machine sales had dropped this quarter for the first time since 2010, and the major writedown from the Chinese acquisition, I can't see how that might help defend the argument for a higher quarterly EPS and stock price.
Regardless of the lower EPS, sales numbers, and the downbeat news, I still feel that the fundamentals and the overall growth story behind Caterpillar still exists. I believe that any weakness seen in the stock should be viewed as a potential buying opportunity.
Factors to Justify Caterpillar's Continued Growth
The China Story Is Far From Over: Many investors have written China off and are anticipating it to continue to decrease in growth and become a non-factor in the coming years. In 2010-11, Chinese policy makers deliberately slowed down their economy because inflation was currently coming in higher than projected targets. This intentional slowing has created an artificial slowing of growth in China, but it will not last forever. The Chinese economy is still very much a growth economy and is still in the middle of a massive urbanization. Policy makers in China are much more focused on quality growth and increased overall productivity. The "real" demand for goods and services in China is still very much alive and should continue to create more and more business for companies like Caterpillar. Overall, I believe that China has been discounted too much and is doing a lot better than most investors believe, especially as the global economy starts to get back on its feet.
Agricultural Industry Growth: I will agree that Caterpillar is not the first household name that comes to mind when thinking about farming, but the amount of market share that Caterpillar continues to take from companies like Deere & Company (DE) continues to grow. It is very easy to look past the booming agricultural industry in this country and not believe that it has a huge impact on Caterpillar, but that would be a huge mistake. Last year, Caterpillar's sales increased by 7% to $1.59 billion, and as corn and soybean prices remain at historical levels, the amount of excess capital that this industry will have each year to upgrade machinery and equipment will only continue to have a huge impact on Caterpillar's bottom line.
Recovering Western Economies: Caterpillar is the clear bellwether for both economic weakness and strength in most western economies simply due to the firm's large size and exposure into multiple segments. Since 2008, the U.S. has curtailed construction spending exponentially, which has adversely affected Caterpillar. Europe obviously has its own set of problems. The region has cut back on spending, especially government spending. In the U.S., I believe that we are starting to approach the bottom of this lagged period of growth. I think there are a lot of signs that things are improving here in the U.S., which can be seen in the increases in the unemployment arena as well as the improvements in new home construction spending. The U.S. government has also been spending a great deal of money on infrastructure improvements, which should also continue to help bolster growth. As construction demand in the U.S. begins to recover Caterpillar should be the clear beneficiary from that increased demand.
So What's the Trade?
As I mentioned earlier, Caterpillar stock has been very range-bound and essentially flat over the past 12 months. I personally like Caterpillar and feel that the company continues to grow even among some of its short-term setbacks. No one wants to buy a stock at the top and lose a ton of money as the price comes down due to an unfavorable earnings announcement. I think this current earnings season has been the most volatile and strange that I have seen for quite some time. Excellent examples of this would be the post earnings stock reactions to both Google (GOOG) and Apple (AAPL). Google reported a 5% increase in its bottom line mainly attributed to the Motorola Mobility acquisition and the stock shot up roughly 5% the next day. Apple on the other hand reported a 13% increase in revenue, but sine the growth and sales numbers did not exceed the street's expectations the stock was punished and sold off almost 12% on the day.
To gain a bit of an edge in the event that an Apple-like event happens, I would encourage traders who are looking to establish a position in Caterpillar to consider selling some cash secured out of the money puts. Selling cash secured puts on a stock allows the seller to pick their entry price (via the put option strike price) while getting paid to wait for the stock to come in to their predetermined entry price.
In Caterpillar's case, I would be a seller of the Caterpillar May 2013 puts at the $90 strike for $2.35; this translates to $235 per option contract sold. Keeping in mind that every option that is sold obligates the seller to buying 100 shares of the stock at that particular strike price if the stock is at or below $90 per share come May option expiration. I like this trade for a number of reasons:
1. The contract expires on May 17, 2013, which is only 108 days from now. In my opinion, this provides just enough time for the option to have some nice time value built into the price, but not so much time that the trader has their capital tied up in a margin account for months on end.
2. The premium of $2.35 (or $235) provides a 2.61% discount on the overall purchase price of the stock at $90 per share, making the real breakeven price of the trade if the seller were put to the stock $87.65 per share.
3. The stock currently is trading for $97.50 per share, so the $90 strike would require the stock to fall 7.70% and remain at that level until expiration in May. Even if that does happen the trader would be buying Caterpillar for $90 per share (with an $87.65 breakeven). Considering the vast range of Caterpillar in the past year and forward valuations an $87.65 breakeven price is not a terrible entry price.
Like any trade, there is some risk with the above mentioned trade, but regardless of what happens I find this trade to be a win-win. EPS for Caterpillar may have come in a bit low at $1.04 ($1.91 adjusted), but considering that economic conditions both here and abroad are beginning to improve, I remain optimistic going into the first quarter.