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With Caterpillar Inc. (CAT) up 39.69% since the beginning of 2010, we take this opportunity to analyze the company in order to figure if the stock is correctly valuated by the market.

Caterpillar operates in three lines of business:

Machinery, which includes the design, manufacture, marketing and sales of construction, mining and forestry machinery—track and wheel tractors, track and wheel loaders, pipelayers, motor graders, wheel tractor-scrapers, track and wheel excavators, backhoe loaders, log skidders, log loaders, off-highway trucks, articulated trucks, paving products, skid steer loaders, underground mining equipment, tunnel boring equipment and related parts. Also includes logistics services for other companies and the design, manufacture, remanufacture, maintenance and services of rail-related products.

Engines, which includes the design, manufacture, marketing and sales of engines for Caterpillar machinery, electric power generation systems, locomotives, marine, petroleum, construction, industrial, agricultural and other applications and related parts. Also includes remanufacturing of Caterpillar engines and a variety of Caterpillar machine and engine components and remanufacturing services for other companies; and

Financial Products, which consists mainly of Caterpillar Financial Services Corporation (Cat Financial), Caterpillar Insurance Holdings, Inc. (Cat Insurance) and their respective subsidiaries.

Currently trading at $78.33, CAT is trading at 9.97% from its all-time high of $87.00 reached 2 times on July 17 and 19, 2007. Actually, CAT has momentum; the stock is trading at only 3.53% from its year high of $81.20 reached on October 21, 2010 just after the publication of the Q3 Earnings of the company.

CAT is a volatile stock. The volatility of CAT is measured by its beta ratio of 1.78, which signifies that the stock has a theoretical volatility 78% higher than the market. The volatility has paid very well for the long term investors who invested in CAT in the past.

We compared the return of CAT with the market (SPY) from the years 1994 to 2010 YTD (As of October 22). All paid dividends are included in the return.

Civil year

Caterpillar Inc. (CAT)

Market (SPY)

1994

24.90%

0.33%

1995

8.74%

37.71%

1996

30.64%

22.35%

1997

31.30%

33.35%

1998

-2.89%

28.49%

1999

5.02%

20.32%

2000

3.36%

-9.70%

2001

13.36%

-11.78%

2002

-9.82%

-21.54%

2003

84.69%

27.88%

2004

19.33%

10.54%

2005

20.36%

4.70%

2006

8.07%

15.61%

2007

20.46%

5.16%

2008

-36.29%

-36.38%

2009

31.34%

26.05%

2010 (As of October 22)

39.69%

7.64%


Over the 17 periods observed, CAT outperformed the market 12 times. An investment made in CAT on December 31, 1993 had an impressive return of 728.20% on October 22, 2010, while an investment in the market (SPY), for that same period, had a return of 218.26%. If we look at the last decade, an investment made in CAT on December 31, 1999 had a return of 281.32% on October 22, 2010, while an investment in the market (SPY), for that same period, had a return of -4.58%. All the paid dividends are included in these returns. The “lost decade” has not been lost for CAT’s long investors.

Let’s have a look at the past EPS, dividend per share and payout ratio of CAT in the first table and at the dividend growth in the second one. (All amounts are split adjusted for the 2-for-1 stock splits of July 14, 2005, July 14, 1997 and September 6, 1994)

Year

Diluted EPS

Dividend per share

Payout Ratio

1991

$(0.50)

$0.15

N/A

1992

$(3.01)

$0.075

N/A

1993

$0.80

$0.075

9.38%

1994

$1.16

$0.1125

9.70%

1995

$1.42

$0.30

21.13%

1996

$1.75

$0.375

21.43%

1997

$2.19

$0.45

20.55%

1998

$2.06

$0.55

26.70%

1999

$1.32

$0.625

47.35%

2000

$1.51

$0.665

44.04%

2001

$1.16

$0.69

59.48%

2002

$1.15

$0.70

60.87%

2003

$1.56

$0.71

45.51%

2004

$2.88

$0.78

27.08%

2005

$4.04

$0.91

22.52%

2006

$5.17

$1.10

21.28%

2007

$5.37

$1.32

24.58%

2008

$5.66

$1.56

27.56%

2009

$1.43

$1.68

117.48%

2010

$3.90 (Estimated)

$1.72

56.11% TTM

Civil Year

Dividend growth

1991 to 1992

-50.00%

1992 to 1993

0.00%

1993 to 1994

50.00%

1994 to 1995

166.67%

1995 to 1996

25.00%

1996 to 1997

20.00%

1997 to 1998

22.22%

1998 to 1999

13.64%

1999 to 2000

6.40%

2000 to 2001

3.76%

2001 to 2002

1.45%

2002 to 2003

1.43%

2003 to 2004

9.86%

2004 to 2005

16.67%

2005 to 2006

20.88%

2006 to 2007

20.00%

2007 to 2008

18.18%

2008 to 2009

7.69%

2009 to 2010

2.38%


The 2010 estimated EPS of $3.90 reflects the middle of the guidance of the company for the full year, which is $3.80 to $4.00 per share. From 1993 to 2010 (2010 estimated), the compound annual growth rate was 9.76% for the company’s EPS, which is excellent. From 1991 to 2010, the company increased its dividend at a compound annual growth rate of 13.69%, which is more than excellent despite the fact that the company cut its dividend by 50% at the beginning of the nineties. If we take 1993 as a starting year, the company increased its dividend each year since 1993.

The year over year dividend increase of CAT fluctuates depending on the economic climate. Overall, during the recession years and the years of beginning of recovery, CAT increases its dividend slightly. For example, from 1991 to 1992, the dividend has been cut by 50%. From 1992 to 1993, there was no dividend increase. From 2000 to 2003, the dividend increases have been very slight. And finally, from 2009 to 2010, CAT increased its dividend by only 2.38%. However, during economic growth periods, CAT has often increased its annual dividend at a two-digit growth rate. We had 3 recessions during the period and overall, we can say that during recessions, the investor of CAT can continue to pocket the dividend despite the fact that CAT is cyclical.

The average payout ratio for the years 1993 to 2010 has been 36.82%. The payout ratio of CAT also fluctuates depending on economic climate. It is high during the recession years and the years of beginning of recovery and low and below the average of 36.82% during economic growth periods.

With an annual dividend of $1.76, a TTM EPS of $3.03, a TTM payout ratio of 56.11% which should reduce with economic recovery, the company will have flexibility to increase the dividend and this one is safe. The current yield of CAT is 2.25% while the current yield of the market (SPY) is 1.86%.

As investors, it’s important to select companies with rising dividends and rising EPS to profit from a rising share price. Moreover, it’s important to select companies that increase their sales year over year to ensure their long term potential growth. Buybacks of shares are also important to boost future EPS. Quarter after quarter, shareholders of a company that repurchased its shares become less and less diluted. Here are Caterpillar’s sales and revenues by year from 1991 to 2011 (2010 and 2011 estimated). We have also included 2010 TTM. You will also find the weighted average shares outstanding – diluted, the sales/share and the price/share (P/S) ratios for the years 1991-2010 (2010 TTM):

Year

Sales and Revenues

Weighted average shares outstanding - diluted

Sales/Share

P/S

1991

$10,182,000,000

808,000,000

$12.60

0.44

1992

$10,194,000,000

808,000,000

$12.62

0.53

1993

$11,615,000,000

819,600,000

$14.17

0.79

1994

$14,328,000,000

820,400,000

$17.46

0.79

1995

$16,072,000,000

800,400,000

$20.08

0.73

1996

$16,522,000,000

777,400,000

$21.25

0.89

1997

$18,925,000,000

761,100,000

$24.87

0.98

1998

$20,977,000,000

736,300,000

$28.49

0.81

1999

$19,702,000,000

718,700,000

$27.41

0.86

2000

$20,175,000,000

697,800,000

$28.91

0.82

2001

$20,510,000,000

694,200,000

$29.54

0.88

2002

$20,185,000,000

693,800,000

$29.09

0.79

2003

$22,807,000,000

702,700,000

$32.46

1.28

2004

$30,306,000,000

707,400,000

$42.84

1.14

2005

$36,339,000,000

705,800,000

$51.49

1.12

2006

$41,517,000,000

683,800,000

$60.72

1.01

2007

$44,958,000,000

659,500,000

$68.17

1.06

2008

$51,324,000,000

627,900,000

$81.74

0.55

2009

$32,396,000,000

626,000,000

$51.75

1.10

2010 (TTM)

$37,679,000,000

651,600,000

$57.83

1.35

2010 (Estimated)

$41,500,000,000

651,600,000 (Latest indicated)

N/A

N/A

2011 (Estimated)

$50,000,000,000

651,600,000 (Estimated)

N/A

N/A


The 2010 estimated sales and revenues of $41,500,000,000 reflect the middle of the guidance of the company for the full year, which is $41B to $42B. The 2011 estimated sales and revenues reflect the guidance of the company for 2011 which is “approaching $50 billion”. Please note that CAT considers its “revenues” coming from its financial products division and its “sales” coming from its machinery and engines divisions. The “revenues” are a small portion of the company’s turnover. (8.82% in 2009)

The compound annual growth rate of the sales and revenues of CAT have been 7.67% for the period 1991-2010 (2010 estimated). If we look at the weighted average shares outstanding as dilution of the company, we can see a very encouraging point: the company repurchased its shares over time. We can clearly see a downtrend of the company’s outstanding shares from the years 1991-2010. The company has today 156,400,000 less outstanding shares than in 1991, meaning an average buyback of shares of 8,231,579 per year over the period. The trend is not linear but it is clearly downward over time. The average price/sales (P/S) ratio is 0.90 for the period 1991-2010 (2010 TTM). For the last 10 years (2001-2010 TTM), the average P/S ratio is 1.03. Over the last 10 years, this ratio remains generally constant over time around the average, with a few exceptions.

Let’s make a forward P/S for CAT. The sales of 2011 are estimated at $50 billion. If the weighted average shares outstanding - diluted remain constant at 651,600,000 that would give CAT a forward sales/share of $76.73. At $78.33, the forward P/S of CAT is 1.02, directly on the average of the last 10 years at 1.03. The stock seems to be well valuated according to the forward P/S theory.

CAT has long been, and remains more than ever, a global company. If we analyze the sales by geographic area since 1985, we can clearly see a trend: The proportion of the sales of CAT coming from foreign markets increased over time compared to the sales coming from the United States. In 1985, the sales from foreign markets accounted for 44% of the total sales of the company, while in 2009, the sales from foreign markets accounted for 69% of the total sales. The company will profit from the growing emerging markets for its new growth cycle.

Here, you will find a table of Caterpillar’s sales by geographic area. Note that these sales by geography don’t include the portion of “revenues” coming from the financial products division.

Geographic Area

2009

2005

2000

1995

1990

1985

Inside the United States

31.00%

47.00%

50.00%

48.00%

45.00%

56.00%

Outside the United States

69.00%

53.00%

50.00%

52.00%

55.00%

44.00%


Let’s have a look at the historic P/E and historic forward P/E of CAT:

Year

P/E at year-end

1993

13.91

1994

11.88

1995

10.34

1996

10.75

1997

11.07

1998

11.17

1999

17.83

2000

15.67

2001

22.52

2002

19.88

2003

26.61

2004

16.93

2005

14.30

2006

11.86

2007

13.51

2008

7.89

2009

39.85

2010 YTD

25.85 TTM

Year

Forward P/E at year-end

1992

8.38

1993

9.59

1994

9.71

1995

8.39

1996

8.59

1997

11.77

1998

17.42

1999

15.58

2000

20.39

2001

22.72

2002

14.65

2003

14.41

2004

12.07

2005

11.17

2006

11.42

2007

12.82

2008

31.24

2009

14.61

The current TTM P/E of CAT is 25.85. For the period 1993-2010 YTD, we have 18 periods of P/E with an average of 16.77. We can clearly see over the period that the P/E of CAT tends to be higher when we are at the beginning of an economic recovery. (Highest levels in 2001, 2002, 2003, 2009 and 2010 TTM) The actual TTM P/E at 25.85 is well above the average of 16.77 but it’s not a sign that the stock is overvalued because we are in a recovery phase.

For the forward P/E of CAT for the period 1992-2009, we have 18 periods of forward P/E with an average of 14.16. The 2 highest levels of forward P/E occurred during the recession years of 2008 and 2001. The forward P/E is more constant over time around the average of 14.16. If we take the current price of the stock at $78.33, and with the average forward P/E of 14.16, the investors would expect EPS of $5.53 in the next 12 months. According to press release of the company dated October 21, 2010, the company expects sales and revenues of approximately $50B in 2011. The last time the company hit the $50B mark for its total sales and revenues was in 2008 with $51,324,000,000. In 2008, CAT had EPS of $5.66 which is very similar to $5.53. The market seems to anticipate this scenario of EPS, which means that the stock would be very well valuated at this moment.

Here are the company’s balance sheets for the fiscal year 1991, 1995, 2000, 2005 and 2010 MRQ (September 30). We have also included the market capitalization at year-end, the total sales and revenues and the total sales and revenues of the following year:

2010 MRQ (September 30)

2005

2000

1995

1991

Total Assets

$61,642,000,000

$47,069,000,000

$28,464,000,000

$16,830,000,000

$12,042,000,000

Total Liabilities

$51,767,000,000

$38,637,000,000

$22,864,000,000

$13,442,000,000

$7,998,000,000

Stockholders’ Equity

$9,875,000,000

$8,432,000,000

$5,600,000,000

$3,388,000,000

$4,044,000,000

Weighted Avg. Common shares Outstanding

632,600,000

678,400,000

693,635,000

793,600,000

807,200,000

Market Cap. At year-end

$49,551,558,000

(As of October 22)

$39,191,168,000

$16,407,935,925

$11,656,000,000

$4,427,492,000

Sales & Revenues

$37,679,000,000

(TTM)

$36,339,000,000

$20,175,000,000

$16,072,000,000

$10,182,000,000

Sales & Revenues of following year

$50,000,000,000 (2011 estimated)

41,517,000,000 (2006)

20,510,000,000 (2001)

16,522,000,000 (1996)

10,194,000,000 (1992)


Over that long period, Caterpillar has been a strong wealth creator for its shareholders. We can see this by the increase of the market capitalization of the company. From $4.4B in 1991, the market capitalization reached $49.55B on October 22, 2010. The company increased its value by constantly increasing its assets, liabilities, shareholders’ equity and its sales over time. Actually, CAT is a leveraged company with total assets of $61.6B and total liabilities of $51.8B. However, as investors we feel comfortable with the situation because we can see that CAT has long been a leveraged company that produced excellent return and wealth creation for its shareholders over time, always adequately dealing with a high-leveraged situation.

When we analyze the progression of the market capitalization of CAT, we can clearly see that market capitalization tends to follow and match the sales and revenues of the following year. For example, in 2000, the market capitalization was $16.4B, and the 2001 sales and revenues were $20.5B. In 2005, the market capitalization was $39.2B and the 2006 sales and revenues were $41.5B, and finally, the actual market capitalization of CAT is $49.55B and the 2011 estimated sales and revenues are perfectly matching at $50B. Once again, the market seems to anticipate this scenario of $50B of sales and revenues for 2011, which means that the stock would be very well valuated at this moment according to this analysis of the market capitalization of CAT.

Here is a summary of the measure of the profitability, the financial strength and the management effectiveness of CAT and 2 competitors (Deere & Co. (DE) and Cummins Inc. (CMI)). Its most direct competitor is Deere & Co.:

Caterpillar Inc. (CAT)

Deere & Co. (DE)

Cummins Inc. (CMI)

Net Margin TTM

4.66%

4.91%

6.54%

Operating Margin TTM

5.58%

9.20%

10.11%

Current Ratio MRQ

1.38

2.35

1.94

Debt/Equity MRQ

3.17

3.90

0.19

ROA TTM

2.64%

2.88%

8.65%

ROE TTM

18.09%

21.98%

20.25%

Note: TTM and MRQ as of June 30, 2010 (CAT & CMI); TTM and MRQ as of July 31, 2010 (DE)

For the measure of the profitability, CAT has a TTM profit margin of 4.66%. The TTM operating margin is 5.58%. CAT is below DE and CMI but the TTM profit margin and TTM operating margin of all these companies are low.

For the measure of the financial strength, the MRQ current ratio is 1.38 for CAT which is correct. Again, the MRQ current ratio of CAT is lower than DE and CMI. The company has a MRQ debt/equity ratio of 3.17 which is lower than DE but quite a bit higher than CMI which is at only 0.19. As previously noted, CAT is a leveraged company; We feel comfortable with that situation because we can see that CAT has long been a leveraged company which produced excellent return and wealth creation for its shareholders, always adequately dealing with a high-leveraged situation.

For the measure of management effectiveness, CAT has the lowest TTM ROA and TTM ROE of the group with 2.64% and 18.09% respectively. The 3 companies have a good similar TTM ROE in a range of 18.09% to 21.98%. Overall, CAT and DE, its most direct competitor, have similar numbers for all the measures of profitability, financial strength and management effectiveness.

The fundamentals of the company are all great: the stock has momentum and is trading at 9.97% from its all-time high of $87.00, paying volatility measured by a more than excellent past return of the stock compared to the market, current yield at 2.25%, safe dividend, growing EPS, global company with growing sales at a beginning of a new cycle of economic recovery and growth, and with a very high proportion coming from foreign markets, profit margin, operating margin, current ratio, debt/equity ratio, ROA and ROE comparable to its most direct competitor, P/E well evaluated in a beginning of economic recovery, correct forward P/E, and finally, the company has a strong historic of buyback of shares.

Moreover, assuming the current price of CAT at $78.33, the company seems to be very well valuated by the market considering our analysis of the forward P/S, the forward P/E and the actual market capitalization that matches perfectly the anticipated sales for next year. At the moment, an investor would pay a fair price for the growth of the next year already anticipated in the stock, and has a good opportunity to take a position for a potential new cycle of economic growth--mainly led by the emerging markets--for the next decade. This strategy makes long term investors richer and rewarded for their vision.

As CAT machinery will build and participate in the development of the next decade, CAT can help investors build strong and performing portfolios.

Source for company description: Morningstar, Inc.

Disclosure: Long CAT, DE and SPY. No position in CMI

Source: Caterpillar: Anticipating a New Cycle of Economic Growth