What Will Lift This Earthmover Out Of Mudville?

| About: Caterpillar Inc. (CAT)

"The outlook wasn't brilliant for the Mudville nine that day."

Casey at the Bat - Ernest Thayer

Caterpillar (NYSE:CAT) is the world's largest manufacturer of earth moving equipment. It has an excellent product line and a presence in virtually every country in the world. In fact, 70 percent of its business is outside North America. With its acquisition of Bucyrus, CAT is also the leading manufacturer of mining equipment. These factors, along with its extensive dealer/service network, provide an enormous moat or barrier to entry.

But all is not well in Mudville. Last year was difficult for CAT. Its fourth quarter profit of $1.04/share was off from $2.32/share a year ago, and the company's revenue projection for this year is modest at best ($60-68 billion projected for the year versus $66 billion last year). Also, the company recently wrote off $580 million of the 2012 purchase of a Chinese mining equipment company that cost $700 million. The write-off stemmed from the Chinese company's accounting irregularities (to use polite language). The write-off caused a big stir and questions about due diligence. But to put things in perspective, CAT, with a market capitalization of $63 billion, paid $700 million for ERA Mining Machinery Ltd. (the Chinese company), but CAT paid $8.8 billion for mining equipment manufacturer Bucyrus in July 2010. The Chinese write-down is a black mark for CAT, but it probably won't be a significant factor in the company's long-term future.

What will lift CAT out of Mudville? Most analysts focus on the internal factors in a company. Certainly, the financial information and ratios are important, and CAT does have some positive financials in addition to an ongoing cost cutting effort. This part of the picture is reasonably good.

CAT Machinery Industry

P/E (TTM) 11.48 21.91

Price/Cash Flow 7.50 12.91

Cash Flow Growth Rate (Last 5 yrs.) 9.74% 8.14%

Forward EPS Growth (3-5 yrs.) 14.0% 10.84%

Gross Margin (Recent qtr. annualized) 30.6% 32.39%

But the most important factor that will move CAT forward will be an increase in the worldwide market for its products. If the world economy improves, then governments, both U.S. and overseas, will be able to undertake long-awaited infrastructure projects, and home construction will improve once consumers are ready to spend.

Overseas, the economic picture, although getting better, is still questionable. The IMF reduced growth forecasts for 2013 with concern about Europe's financial problems and the ongoing budget problems in Washington. Nevertheless, the IMF expects the world economy to grow 4.1% in 2013, up from 3.5% in 2012.

Domestically, residential and non-residential construction is now finally on the upswing, with housing starts in September the highest in four years. The architectural billing index (ABI) moved into positive territory last August, and in September, reached its highest point in two years. Non-residential construction is predicted to increase 6.2% this year. In the U.S., every state has road, bridge, and public building projects that are on hold, awaiting funding.

What does this mean for CAT? The long-anticipated improvement in the world economy now appears to be slowly gaining momentum. As government and private sector construction picks up in the U.S. and abroad, the demand for Caterpillar equipment will increase, and the company will enjoy the great competitive advantage it holds throughout most of the world.

Will the economic rebound really happen this year? Hopefully, yes. If not, it will occur in the not too distant future.

As noted, CAT's profit and other performance indicators were down last year and may struggle this year. But overall, CAT is in pretty good shape. S&P projects a 12 month target price of $117, which sounds reasonable, if a little optimistic, and with a current yield of 2.2%, CAT is a good long-term buy. It will take some time to develop, but the stock looks pretty cheap right now, particularly for the patient investor.

Disclosure: I am long CAT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.