Past Performance: Caterpillar has beaten EPS expectations once in the past six quarters, three times in the past sixteen quarters, and only once in the first quarter over the last four years. Caterpillar missed EPS expectations last quarter, reporting only $1.46 EPS versus expectations of $1.69 EPS. Caterpillar (NYSE:CAT) is expected to achieve $1.46 EPS in the first quarter of 2013, that represents a nearly 38% decline in EPS YOY.
Fundamentals: Caterpillar has exceptionally strong fundamentals both compared to the S&P 500 and the industrial sector. Currently, CAT trades with a P/E of 10.57, a Forward P/E of 9.52, a P/S of 0.91, and a PEG of 0.80. The S&P 500 has a 20.4 P/E and the industrial space has a P/E of 21.4. Likewise, the S&P's Forward P/E is 17.7, and the industrial sector's Forward P/E is 16.8. Caterpillar fundamentals are much stronger than both the S&P 500 average and the industrial industry. While Caterpillar may have lowered forward guidance in September of 2012, the company seems undervalued currently considering the absolute tear the market has been on all year. If Caterpillar had a P/E equal to just the industrial sector's average, the stock would be trading north of the $100 level.
The Story: The sequester and prolonged low interest rates are going to affect Caterpillar's bottom line, much like basic materials play Alcoa (NYSE:AA). The sequester is forcing massive budget cuts on the federal government, to the tune of $1 trillion over the next decade. Those budget cuts will adversely affect Caterpillar. Military spending is one of the areas slated to suffer the brunt of the cuts, which means Caterpillar's machinery used overseas to help build outposts, power outposts, and various other uses the military has will be cut as well. Caterpillar will also enjoy less government contracts from infrastructure spending as those programs become scaled back versions of their former selves to save money.
Low interest rates are also adversely effecting CAT. Banks are lending less to businesses as they can make a better return by investing those funds outside of making loans. Fewer loans, means less expansion by businesses. Less expansion means less demand for CAT machinery. In order for CAT to enjoy more robust growth, they need new home building, new car sales, and employment numbers to spike upward. If that trifecta can come to fruition, CAT should enjoy robust growth. A weak Chinese economy can be discounted from adversely affecting CAT to a severe degree as China only accounts for 3% of Caterpillar's bottom line.
Also take in to account the technicals side of the picture. Caterpillar is only about thirteen percent away from its 52-week low of $78.25. The chart also shows support at the $80 level, with an ascending triangle beginning to take form. The RSI and Slow Stoch have only just edged north of oversold territory, with the Fast Stoch still in an upward trend nearing the breakeven level.
Summation and How To Play CAT: Caterpillar would obviously benefit from a more robust world economy. A Chinese slowdown, European slowdown, and a recovering US economy is making it difficult for the blue chip industrial play to thrive. The industrial space may not be the darling of the market currently, being the second most shorted industry in the market with a 3.1 days to cover measurement. However, it would only take market expectations for an increase in interest rates to bolster the entire space. I would recommend moving in to Caterpillar before they report earnings. 52-week price target: $114.86.
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.
Additional disclosure: Always consult with a registered financial professional before adding a new position to your portfolio. Investing always involves a significant risk of loss, as such never invest more than you can afford to lose.