I advocated selling Caterpillar (CAT) stock in a recent SA article due a number of reasons. I had received a lot of blowback from readers and there was even an article dedicated to rebutting my arguments. Writing short articles is never popular because most investors are buyers and do not like to receive contrary opinion. Also writing negatively about some stock is not rewarding if you are a writer or a sell-side analyst. Even if you look at a sell-side report, you will find that the "Sells" recommended by short sell analysts are only a small fraction of their "Buy" recommendations. What people don't realize is that the short articles (if they not biased) are much more valuable than the long articles on different stocks. If you look at General Electric (GE) articles on SA, you will find tons of articles advocating a long thesis compared with just one or two that have a short thesis. CAT stock is now down ~15% from the time I recommended you were better off selling CAT to look for other alternatives. While investors who had sold the stock short might look to take some profits, others should not look at buying CAT stock just now. The reason is that I think the global economic slowdown will hurt CAT more going forward in 2013.
Why we would still be sellers of CAT
- Bad quarterly results and even worse 2013 guidance - CAT management in its previous-quarter earnings said that 2013 will be a bad year and gave a very wide range of $7-9 in annual EPS. If CAT hits the lower end of the range, the stock will easily go down to the $70 range, based on the current P/E ratio. The stock has reacted badly to management guidance and is down almost ~13% after the earnings. Note Caterpillar missed 4Q12 EPS, reporting only $1.46 EPS versus expectations of $1.69 EPS.
- Global economic slowdown is seriously hurting CAT - One of the risks we highlighted with CAT was that the company was leverage to a global economic slowdown. That risk seems to be coming true with CAT reporting a sharp drop in sales throughout the world in February. The company's sales of retail machinery were down by a massive 26% year/year in the Asia Pacific region. One of the strengths of a global business like CAT is its ability to offset decline in some regions with growth in other regions. However, CAT is now being faced with a simultaneous decline in almost all parts of the world. While European sales are in a bad shape (down 9% y/y), other fast growing places like Asia-Pacific are doing even more badly. I don't think the situation is going to turn better in 2013. Though the stock markets are exuberant due to super low interest rate environment, the real economy is probably in a worse shape since the Lehman crisis. The European crisis seems to be never ending with Cyprus inciting the latest bout of the European crisis. The whole economy remains mired in an unemployment and recession quagmire. India saw the steepest decline in vehicle sales in February while China's over investment bubble remains a huge problem. The U.S. seems a bright spot but the trillion dollar deficits will lead to government cutbacks.
Machines Retail Statistics1
1 Reported in constant dollars and based on unit sales as reported by dealers.
*EAME (Europe, Africa, and Middle East)
*ROW (Rest of the world - everything except North America)
Source - Caterpillar
Stock Performance and Valuation
CAT has underperformed the broader market index in the last three months by almost 10 percentage points. Other competitors like Joy Global (JOY) and Komatsu (OTCQB:KMTUY) have also been down during this period, as the slowing of economic growth hurts all the industrial companies. The last month has been particularly bad, with CAT down 7%. Caterpillar's Valuation is in line with the rest of the industry with a P/S of 0.9x . The P/B ratio is ~20% higher than the industry average at 3.3x. The dividend yield at 1.73% is below the ~2% for S&P 500.
Caterpillar is one of the largest industrial companies but secular and cyclical headwinds make it a bad investment right now. The company's revenues and earnings are both going to fall down in 2013; the only question is by how much. Even CAT management does not have an answer to this question and is hoping for a 2H 2013 recovery. The company is heavily leveraged to global infrastructure investment, which is slowing down. All major economic powers are going to slow investment as austerity starts to bite. China has to slow down investment quite drastically in the coming years as its over investment bubble bursts. The largest global solar panel company Suntech has just announced bankruptcy as crazy over investment in solar manufacturing starts to take a toll on weaker players. Other sectors like shipbuilding, steel, wind turbines and construction will also start to slowdown. I would advise investors that selling CAT is still a good idea right now to look for better alternatives. You don't want to hold on to a stock where even the management does not know how much the earnings will decline. I would propose that investors might look into buying another agricultural machinery company Deere (DE), which has better secular growth prospects compared with the other industrial heavy machinery makers like Komatsu, Joy etc.