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Summary

  • In the latest instalment of our Head-To-Head series, we pitch two companies from the industrial sector, Caterpillar and Deere, against one another.
  • The article focuses on the relative strengths and weaknesses of Caterpillar and Deere based on business performance and sustainability/dividends.
  • It concludes by discussing the current valuations of the two companies, and answers whether Caterpillar represents good relative value at current price levels.

Caterpillar Background

Caterpillar (NYSE:CAT) was founded in 1925, and is headquartered in Peoria, Illinois. It manufactures and sells construction and mining equipment, diesel and natural gas engines, industrial gas turbines, and diesel-electric locomotives worldwide. The company's Construction Industries segment offers construction machines and related parts. Its Resource Industries segment provides a number of parts to the mine, quarry, forestry, paving, tunneling, waste, and industrial customers. The company's Power Systems segment offers reciprocating engine-powered generator sets, as well as integrated systems for the electric power generation industry. Its Financial Products segment provides retail and wholesale financing alternatives for Caterpillar equipment, machinery, and engines.

Team Money Research Rating

Our investment philosophy is to focus on company fundamentals and identify stocks that are displaying strong business performance, that operate sustainably and that pay a decent, well-covered dividend.

We score each company relative to the other on the following criteria within each of our two main buckets:

Business Performance

  1. Return on equity
  2. Return on assets
  3. Operating margins
  4. Quarterly revenue growth
  5. Quarterly earnings growth

Sustainability/Dividends

  1. Debt to equity ratio
  2. Interest cover
  3. Dividend payout ratio
  4. Forward yield
  5. 5 year average yield

Once we have scores for the two buckets, we can then assess whether a company represents good value based on the current prices of the two stocks. We use the following criteria to assess valuations on a relative basis.

Valuation

  1. Forward price to earnings ratio
  2. Price to book value ratio
  3. Enterprise value to EBITDA
  4. Price to sales ratio
  5. 5 year price to earnings growth ratio

So, for example, a company that scores well compared to its rival on the first two buckets (business performance and sustainability/dividends) and that is undervalued relative to its peer (based on the third bucket: valuation) could outperform its competitor going forward.

The table below highlights the data that we will use to score Caterpillar and Deere (NYSE:DE) for the first two buckets.

Stock

Caterpillar

Deere

Business Performance

Return on equity

19.88%

36.61%

Return on assets

4.31%

5.59%

Operating margins

10.71%

14.35%

Quarterly rev. growth

0.20%

-8.80%

Quarterly EPS growth

4.80%

-9.50%

Sustainability/Dividends

Debt to equity ratio

187.22%

341.18%

Interest cover

13.20

9.83

Dividend payout ratio

39.00%

22.00%

Forward dividend yield

2.60%

2.60%

5 year average yield

2.40%

2.20%

We then score each company relative to its peer based on the above data, with points being awarded as follows:

1st place: 10 points

2nd place: 0 points

Below are the scores for Caterpillar and Deere:

Stock

Caterpillar

Deere

Business Performance

Return on equity

0

10

Return on assets

0

10

Operating margins

0

10

Quarterly rev. growth

10

0

Quarterly EPS growth

10

0

Sustainability/Dividends

Debt to equity ratio

10

0

Interest cover

10

0

Dividend payout ratio

0

10

Dividend yield

5

5

5 year average yield

10

0

Total Score

55

45

As you can see, Caterpillar just manages to squeeze out Deere by 55 points to 45. Scores between the two companies were fairly close in the business performance bucket, with Deere edging out Caterpillar due to its higher return on equity, return on assets and operating margins. That's not to say that Caterpillar isn't hugely profitable of course, but it has fallen behind its peer at the moment on this front. Although Caterpillar beat its rival in terms of top and bottom-line growth last quarter, its quarterly revenue growth was only 0.20%, which is not hugely impressive and highlights the challenges the company is facing in increasing sales.

Meanwhile, Caterpillar scored well on the sustainability/dividend bucket, with the company having a much lower debt to equity ratio than its peer, as well as a higher interest coverage ratio. This shows that investors in Caterpillar should be comfortable with regard to its sustainability, and the company does not appear to have an overly risky balance sheet. As for dividends, it was a tie and both companies could be of interest to income-seeking investors right now.

Valuation

So, we feel that the two companies are fairly evenly-matched and should, therefore, trade on similar valuations. Since it scored higher than Deere, we would expect Caterpillar to be slightly more expensive at current levels. Let's see if it is.

Stock

Caterpillar

Deere

Valuation

Forward price to earnings ratio

15.22

11.55

Price to book ratio

3.39

3.04

EV/EBITDA

11.29

10.17

PEG

1.38

1.31

Price to sales ratio

1.23

0.88

Despite the two companies being pretty evenly-matched in the first two buckets, it's clear that Caterpillar is considerably more expensive than its industrial peer. Indeed, Caterpillar offers less value on each of the five valuation metrics above, with the biggest difference between the two companies being seen in the forward price-to-earnings-ratio, where Caterpillar has a forward P/E of 15.22 and Deere has a forward P/E of just 11.55. This shows that Caterpillar may be overvalued relative to its peer at current price levels, since although it did score slightly higher in the first two buckets, its valuation premium to Deere seems rather large.

Conclusion

Caterpillar is a great company that appears to be highly priced when compared to its industrial peer, Deere. Although it scored highly on the Team Money Research rating system and beat its sector peer by a narrow margin, it also appears to be relatively overvalued at current levels and, as such, could underperform its sector peer going forward.

Feedback Request: What do you think about Caterpillar? Would you buy, sell or hold right now? Please comment below!

Source: This Company Makes Caterpillar Look Expensive