By Matt Doiron
Caterpillar Inc. (CAT) is down 5% year-to-date against a rising market. At a beta of 1.8, the company's fortunes are tied to the macro situation, which is always a concern for many investors. In particular, the construction and mining machinery company is seen as highly exposed to the Chinese economy both directly and through Australian operations. In addition, Caterpillar was forced to report a significant earnings write-down last quarter on a Chinese acquisition which proved to include substantial fraud.
The company's 10-K reported that revenue increased by 10% in 2012 compared to the previous year, which represented a slowdown in sales growth from 2011 but is still quite respectable. Even with the goodwill impairment charge related to the Chinese subsidiary, operating income was up 20% reflecting an actual increase in margins as Caterpillar's business grew. Earnings per share came in at $8.48, up from $7.40 in 2011 (a 15% increase) and $4.15 in 2010. However, in the fourth quarter sales fell versus a year earlier and net income missed Street expectations. So we would certainly worry that Caterpillar will not do as well this year.
The current market capitalization of $59 billion represents a trailing earnings multiple of 11, which would be in line with a company experiencing constant to slightly declining earnings. In other words, the market is not pricing Caterpillar as if it will actually improve over the next couple years. Analyst expectations are for at least modest growth over the medium to long term, resulting in a forward P/E of 9 and a five-year PEG ratio of 0.8.
The largest holder of Caterpillar stock in our database of 13F filings for the fourth quarter of 2012 was the Bill and Melinda Gates Foundation, which reported owning over 10 million shares (see more of the trust's stock picks). Renaissance Technologies, whose founder Jim Simons is now a billionaire, increased its stake in Caterpillar to a total of 1.3 million shares between October and December (find Renaissance's favorite stocks). Billionaire David Shaw's hedge fund D.E. Shaw was also buying shares. Check out more stocks D.E. Shaw was buying.
Caterpillar's peers include CNH Global NV (CNH), Joy Global Inc. (JOY), and the more agricultural equipment-oriented Deere & Company (DE) and AGCO Corporation (AGCO). CNH and Joy both trade at 9 times their trailing earnings, or something of a discount to Caterpillar. Betas at these two peers are a bit higher, possibly in part because they are significantly smaller in terms of market cap. Both CNH and Joy reported essentially flat revenue and earnings in their most recent quarter compared to the same period in the previous fiscal year, potentially giving them another advantage over their larger peer. As such, we think that investors interested in Caterpillar should look at these other two stocks. They may be more vulnerable to a downturn, but also seem like better values.
Deere and AGCO's trailing P/Es are in the 10-11 range, meaning that this peer group in general trades within a very narrow range. While both of these companies have been reporting decent revenue growth rates, net income dropped 64% at AGCO last quarter compared to the fourth quarter of 2011. We'd therefore be more careful evaluating that company's prospects. Deere has been doing better - in fact, its margins have actually been up, at least recently - and certainly its premium to the other companies we've discussed is small enough that a superior business performance, if it could be sustained, would make it a better buy.
In absolute terms, we can see the value case for any of these stocks (though we would want to be sure to address the recent financial trends at Caterpillar or AGCO). Joy Global and CNH Global seem cheap, while Deere's growth rates have been well above what we normally expect at that low a multiple.