I am bullish on Caterpillar (CAT). But not from here, Caterpillar is setting up for a drop that will likely take it under 70 into the first part of 2014. My ideal purchase price is 68.
After a meteoric rise off the 2009 low and then another new high off the 2011 low CAT gave a lot of those new gains back falling 33% into July 2012. While it has a much higher beta (1.97) the ups and downs have tracked largely with the broad market. However, since February this year it has fallen significantly behind the S&P.
Quarterly revenues and EPS are down this year from the banner year in 2012. That could be a factor in why it has trailed the market since June, but it certainly does not explain why the bulk of the drops began ahead of those in the market (Feb of both 2012 and 2013) by at least a month. Furthermore one can see almost polar opposite responses to virtually identical quarterly earnings reports issued only 6 months apart (April 22 and Oct 22). There have to be other factors effecting investor sentiment.
Caterpillar relies primarily on three sectors for revenue: infrastructure, power, and mining. But mining is the flagship and has been the strongest profit center, contributing 4.3B of the 2012 profits at roughly a 20% profit margin. It is then no surprise that a very large corrective slow down in global mining has weighed heavily on CAT like a 797F.
The GDX hit its high in September of 2011. CAT was able to stand up to the pressure pretty well from October 2011 through February 2012 with the help of a very strong S&P. However from the end of February that year both dropped the same 33%, and then both enjoyed similar rebounds with the mining index leading there by a few months. Then again in February 2013 when the GDX broke under a down trend line that had been providing support and began to "water fall" dropping another 35% in just 2 months CAT followed suit managing to only decline 20%.
Since April the mining industry has continued to work its way lower toward completing a much larger correction, but CAT has been buoyed somewhat by the strength of a continued broader equity rally and of the other sectors of its business. GDX may spike lower still but I do think it is nearing the end of this extended drop of almost 70% from 2011.
CAT has held in a narrowing range (a triangle if you will) making a series of lower highs and higher lows. I think this ended with the reaction to the October earnings announcement. I posted that chart set up for my Stock Waves subscribers as an earnings play on 10/18 and then again on 10/22, before CAT reported on 10/23 before the open.
After that initial drop to 82 it had a corrective bounce retracing 61.8% of the drop from 89 and is now set up for the next stronger leg down targeting the mid 70s and then ultimately continuing to my ideal target of 68.
What fundamental metrics could explain a continued drop in the short term and also set the stage for another meteoric rally? From a fundamental standpoint CAT is not an unattractive stock here. Its P/S of .99 and P/E of 16.23 are very reasonable and at the current share price its consistent dividend yields 2.8%. Even amidst slowed revenue from the mining business CAT maintains a firm grasp as the global leader and "yellow" standard. Its leadership has done great work anticipating and responding to changing economic circumstances. And its significant investments in R&D particularly in the power sector will continue to maintain both a technological and functional edge as well as create additional opportunities and synergies between the power and infrastructure sectors.
Since February's high though, the P/S has barely clawed its way back to the 1.0 top hit earlier this year. And the P/E just recently hit the same level where it topped in February 2012. At my price target of 68, using the same 5.25 EPS, P/E would then be a far more attractive 12.9, and also put it back clearly in the historic "bottoming zone" for Caterpillar. 68 would also translate to a 43.3B market cap, a retrace a 50% of the gain off the 2009 low. And based on the projected revenues for 2013 P/S would likely fall between 0.82-0.75, a 61.8% retrace of the move up in P/S off the 2009 low. While not nearly as extreme of a low as that of 0.30 in March 2009 it is certainly in-line with the low in 2002, which sparked a 400% rally. Finally at 68 the same consistent dividend raises the yield to 3.5%, a 25% raise from what current investors are being paid.
I do not add positions to my portfolio though just because they seem like a value. And while 3.5% yield may seem great to some I view it as part of the carrot that will bring other investors back in and an added bonus for a longer term hold looking for double (or even triple) digit growth. I want to own because I see long term potential in CAT to reach current AAPL level prices over 2-3 years before those Fundamental measures really reach extreme levels. A P/S of 2.05 would have me really looking for additional indications of a pending top, and 2.54 would likely have me salivating for a short. My initial target from 68 is 130-140 after breaking though the resistance in the 80s. At that point, or potentially not until closer to 180-200, P/S should be approaching 1.25 and CAT will be ready for a nap, but it should be soon ready to play again and then really soar.
I also see similar drop and then rally potential in JOY and DE, but I like the long term potential on CAT much more. If a reversal where not to come at my ideal 68 level I would be looking for an extension lower toward 60-56 for the next support. I will also be watching the development of the move down for indications that it might truncate in the low 70s, and may begin to layer into a hedged long position then.
Additional disclosure: I primarily base my trading decisions on chart patterns and technical analysis. Patterns can change quickly, and I am constantly looking for new support levels to lock in gains and minimize potential losses.