Caterpillar (CAT) has received a lot of downgrades lately due to the slump in the (gold)miners industry. Are these sell recommendations justified or has the recent decline formed an attractive new entry point?
Caterpillar witnessed sharp downward estimate revisions after reporting disappointing first-quarter 2013 results on April 22nd. Revenues slumped 17% year over year to $13.2 billion and earnings per share declined 45% to $1.31, mainly due to reduced mining demand and decline in inventory.
Caterpillar, 5 years graph, source: yahoo.finance.com
Caterpillar is without any doubt suffering from the slump in the mining industry. The dealer network has already anticipated the fall in demand for mining equipment and has drastically lowered its stock of machinery. Because of the careful outlook of the miners, Caterpillar took severe measures to lower production of the mining equipment. It is quite clear that Caterpillar, as a major supplier to mining companies, is very vulnerable for the falling commodity prices. The question is, of course, how vulnerable. The estimated net profit for 2013 has already been lowered substantially to $7 per share and turnover for 2013 is forecasted now between $57 billion and $61 billion.
As stated in a Caterpillar article from Hawkinvest, another growing problem is the plunge in the yen towards the dollar. The Japanese competitors are benefiting from the extreme quantitative easing by the Bank of Japan which lowered the yen already by 20%. On the other hand, in the past, Caterpillar has profited many times from the same policy issued by the Federal Reserve.
Look at the chart above. Already in April 2012, more than a year ago, CAT and the Dow Jones changed course. On April 23rd 2012, the Dow Jones Index (DJI) stood at 12927 while Caterpillar shares changed hands for $106. So Caterpillar shares not only corrected 21%, they also missed the 18% rally in the overall index. To issue a sell recommendation at this point of time is at least a little late.
If you are long Caterpillar shares, there are a couple of highlights in the Q1 report which should not be overlooked:
- With an estimated net profit of $7, the company is valued at 12 times earnings.
- 20% of the company's workforce is in Japan, the fall of the yen therefore is not as much a problem as analysts might think.
- global economic growth is about to stabilize.
- balance sheet is stronger than ever.
- commodity prices have fallen but are priced attractively at the moment.
- mining is important, but not the only division of Caterpillar.
To emphasize the confidence in the company's future, the management decided to reopen its share buyback program. As CFO Brad Halverson stated in his comments on the Q1 report: "With the recent decline in the stock price, this is an opportune time to do it and reinforce our confidence in the long term future of Caterpillar." Now I am not a big fan of share buyback programs, but the strong balance sheet and cash flow more than justify this measure.
It is true, Caterpillar is heavily affected by the slump in the mining industry and the plunge of the Japanese yen. But much of the pain has already been priced in and the company's management deserves a little credit when they speak out their confidence in the recovery of the mining industry. Much depends on the stabilization of the commodity prices.
Nonetheless, Caterpillar is more than a mining equipment manufacturer. At 12 times earnings, Caterpillar is one of the most attractive Dow components. There might be a challenging year ahead, but at some point commodity prices will stabilize. Long-term investors have experienced a 20% decline in the stock as well as a total absence in the recent stock rally. The odds of selling the stock at this level don't seem favorable. A stabilization of the commodity prices can be the impetus to a renewed rally in the Caterpillar shares.