Caterpillar (CAT) was the dog of the Dow Jones Industrial Average in the first quarter of 2013, but what of Q2? The Dogs of the Dow Theory is certainly influenced by turn of the year tax considerations, so maybe it is useless to blindly buy these stocks at the turn of a quarter. However, money is definitely seeking new value after having driven up consumer staples like Johnson & Johnson (JNJ) to levels I view excessive. Still, what it may take for Caterpillar's share price to appreciate, the market may not have. I'm talking about a real global economic catalyst. Even so, with its increasing presence in China and beaten down valuation, CAT presents an interesting prospect for long-term investors who will increasingly seek out value. As for the short-term though, new question about housing and manufacturing mean more tough going for CAT.
Caterpillar was the poorest performing stock of the Dow Jones Industrials in the first quarter of 2013. For informational purposes, Hewlett-Packard (HPQ) was the best performer, rising 68% after adjustment for dividend. CAT, on the other hand, slipped 2.9% against the SPDR Dow Jones Industrial Average (DIA) rise of 11.9%, after adjustment for dividends. The route to CAT's underperformance was not straight though, as you can see by the chart for the quarter here.
Caterpillar had a first quarter disruption. EPS estimates took a hit after the company reported accounting problems with an acquired Chinese subsidiary. Of greater concern to ongoing prospects, Caterpillar also reported expectations for a difficult first half of 2013 and noted a high degree of uncertainty about the second half of the year. As a result, the company's forecast range for its 2013 operational results is wide. It extends to a level deeply under its 2012 operational performance, and so the investment community reconsidered the shares and left it out of the first quarter rally.
Caterpillar Results & Forecast
$60 to $68 Billion
$7 to $9 Per Share
$8.48 Per Share
The analysts' consensus for 2013 EPS is now $8.01, significantly short of where it stood 90 days ago, at $8.70. The estimate for 2014 is likewise less than it was 90 days ago, now $9.38, versus $9.89 previously. In its own discussion, Caterpillar talked of a weak economic situation in the United States, a recessionary environment in Europe and a slowing China. For 2013, the company is keeping an eye on positive signs in the U.S. and growth in China, but we have our own questions about the U.S. economy.
The performance of the Farm & Construction Machinery makers reflects a troubled global economy. Stocks have risen this year, but serious economic questions are being posed today. Whether stocks continue higher or not will likely depend on the economy and whether capital flows continue heavy into equity funds. We just weighed the issues in our piece, Sell the SPY on High?
First Quarter Performance
Industrial Select Sector SPDR (XLI)
AB Volvo (VOLVY)
Not all industrials did poorly in the first quarter, as evidenced by the double-digit gain of the Industrial Select Sector SPDR. Volvo (VOLVY) benefited from its diversified offerings. Certainly exposure to China is important moving forward, and Caterpillar is moving on China in a big way. After the opening of a facility last week, Caterpillar now brags of 24 factories in operation in China today. So as the company cuts inventory in its weak markets today, including in the U.S. and Europe, it is building out its business where tomorrow's growth will come from.
As I alluded to in my article on the SPDR S&P 500 (SPY), capital flows may shift in favor of stock market laggards with potential. Caterpillar would seem to fill that bill if its U.S. market finds some traction and as its business in China gains steam. Certainly construction has been improving in the U.S. as the housing market seems to have clearly bottomed. However, last week produced some question about housing, with Pending Home Sales and New Home Sales slipping against the prior month's data. Today, manufacturing, the other economic linchpin, faced serious question when ISM's Manufacturing Index fell significantly. I warned it would happen in my article, This Week Manufacturing May Mess Up the Economic Perspective.
As for valuation, CAT is now trading at a discount to sales, at 0.86X trailing 12 months sales. After its price and EPS adjustments, the stock now trades at 10.9X the consensus EPS estimate for 2013. Meanwhile, growth is estimated at 17.1% for 2014 and 14% for the next five years. It's just the next six months to a year that seems to be getting in the way of the stock. The stock's PEG ratio of 0.8X on 2013 EPS estimates and the long-term growth forecast is not expensive. Thus, given its increasing presence in China, and with my sense that capital will increasingly seek value, CAT presents an interesting long-term prospect. Over the short-term, though, you may want to close your eyes and hold your nose if you buy. Better to wait until a better day.