In an age when the products and services many companies make money on are growing more complicated, it's nice to have a business like Caterpillar (CAT) to analyze. Determining the strength of the heavy equipment maker doesn't require a tutorial on valuing digital content or understanding the income potential of "likes" and "tweets." Caterpillar Inc. manufactures and sells construction and mining equipment, diesel and natural gas engines, industrial gas turbines, and diesel-electric locomotives worldwide - aka tangible assets.
What concerns investors about Caterpillar is that after three years of double-digit earnings growth, prospects are dimming. The company's fourth-quarter profit of $1.04 a share was less than half what it earned in the fourth quarter of 2011. What's more, Caterpillar projects little to no revenue growth and a possible decline in earnings for 2013.
Another concern arises from the recent announcement of taking a $580 million writedown for ERA Mining Machinery, a Chinese equipment maker Caterpillar purchased in June 2012. An audit revealed account discrepancies, leading to the extra impairment charge, which equaled about two-thirds of the $886 million purchase price. Though the amount of the writedown had little impact on the global giant, the lack of due diligence in acquiring the firm gives investors some pause. However, those still bullish on the company believe the incident will make Caterpillar more careful about future acquisitions.
Also disconcerting to some stock watchers is Caterpillar's wide 2013 earnings guidance of between $7 to $9 a share. The inability of the company to narrow down that range led one analyst to say, "it basically has no idea how business is going to be this year."
Despite the poor fourth-quarter results, Caterpillar had a decent overall year in 2012. Sales increased from $60.14 billion in 2011 to $65.87 billion in 2012, while earnings per share reached $8.48, a 15% growth compared with $7.40 per share in 2011.
Caterpillar improved its performance in the financing area. According to its quarterly financial press release, new retail financing for 2012 was $13.96 billion, an increase of $2.63 billion, or 23 percent, from 2011. The increase was a result of growth across all operating segments, with the largest increases occurring in the Europe and Caterpillar Power Finance, Asia/Pacific and Mining operating segments.
During 2012, CAT's overall portfolio quality reflected continued improvement. At the end of 2012, past dues were 2.26 percent compared with 2.80 percent at the end of the third quarter of 2012 and 2.89 percent at the end of 2011.
Write-offs, net of recoveries, were $102 million for the full-year 2012, compared with $158 million for 2011. Full-year 2012 write-offs, net of recoveries, were 0.42 percent of average annual retail portfolio, compared with 0.70 percent in 2011.
Caterpillar has continued to improve its balance sheet. Its cash position grew 80% to nearly $5.5 billion at the end of last year. Its growth in total assets outpaced the increase in current liabilities, 9.7% to 4.7% respectively.
What stands out the most about Caterpillar is the fact that the company has better profitability and management efficiency ratios than its competitors. Caterpillar's sales growth for the past five years is near 8%, while the industry average has -20% sales growth for the same period. Its last 12 months net profit margin of 8.7% blew away the industry average of .09%, though the company trails the industry five-year average for net profit margin.
Caterpillar's return on assets, which measures how much the company makes from its existing assets, bested the industry average for both the last 12 months (7.2% to 6.8%) and the average for the last five years (4.7% to 3.7%). The same holds true for the company's return on investments, which measures how much a company earns on its invested capital. In the previous 12 months, Caterpillar had an ROI of 14.7%, slightly above the industry average of 14.2%. The five-year average ROI for Caterpillar was above 10%, compared with the 6.7% for the industry.
Despite these superior numbers, Caterpillar is priced moderately in relation to its earnings than its competitors. Its current price-to-earnings ratio was 11.41 on February 8, compared with CNH Global's (CNH) 10.18 and AB Volvo's 13.61. Caterpillar looks better when compared on an EV/EBITDA (also known as Enterprise Value) basis. Of these three, Caterpillar generated a 14% operating margin in 2012, the highest among the three. The operating margins of CNH and AB Volvo were 10% and 7%, respectively.
Caterpillar is clearly the dominant player in its industry and has the appearances of a well-managed company. Therefore, any investment decisions on Caterpillar will likely be based on how confident investors are in the direction of the economy and whether the global market for earth-movers will grow.
The International Monetary Fund forecasts world economic growth of 3.5% in 2013, up slightly from 3.2% last year. Stronger growth of over 4% is projected for 2014. Growth could be stronger, the IMF says, if crisis risks do not materialize and financial conditions continue to improve.
Economic growth, which should result in increasing tax receipts, will provide the necessary funding for local, state and national governments to take on much-needed infrastructure projects. Those projects will need construction equipment. However, the McGraw-Hill Construction Forecast for 2013 reports declines in public works projects in the U.S. for this year.
The forecast also reports an anticipated 6% growth in overall construction in the U.S., up from 5% growth last year and significantly higher than the 1% and 2% growth rates from 2009 and 2010, an indicator of an improving domestic economy. Most of these gains will be in single-family housing, multi-family housing and commercial projects.
Furthermore, a continuing low interest rate environment should persuade construction companies to finance the purchase of new equipment.
In addition, Caterpillar has a strong presence in China, whose economy is expected to grow more than 8% in 2013 and 2014 according to IMF.
Analysts say the bottom line on Caterpillar is that it's a good buy at its current price. Though it may take time for the stock price to appreciate and reward investors, the company's strong management and financial position will allow it to take advantage of long-term economic growth better than its competitors.