Why I Am Short Caterpillar

Jan.31.11 | About: Caterpillar Inc. (CAT)

Caterpillar (NYSE:CAT) reported a pretty decent quarter today. Sales of 12.81b and EPS of 1.47/share easily beat the street expectation of 11.72b and 1.27/share. While analysts were somewhat disappointed with increased costs contributing to weak margins, it was difficult to find fault with the raw numbers. Additionally, Caterpillar raised forward guidance to $6.00/share for 2011.

From Andrew Obin, Anna Kaminskaya, and Samantha Speer at Bank of America/Merrill Lynch we have the following:

"CAT reported a mixed quality quarter, with very robust volume recovery in both segments ($0.17/sh beat) and healthy pricing ($0.04/sh beat), offset by weak incremental margins of 21%, particularly in Machinery at only 19%. We were especially disappointed by the ramp-up in the manufacturing costs that came ~$0.18/sh higher than our forecast.

"Beat mostly on tax, weaker margins offset stronger top-line CAT’s 4Q10 EPS of $1.47 came ahead of our estimate of $1.28 and consensus of $1.27. The majority of the beat (~$0.16/sh) came from lower tax rate of 19% vs. our est. of 29%. Operating income line was ~$0.08/sh ahead of our forecast on stronger-than-expected top-line in both segments (Machinery up 88% vs. our est. of up 60%, and Engines up 36% vs. our est. of up 25%), which was offset by margin miss in both segments (Machinery at 8.2% vs. our forecast of 9.0%, and Engine at 15.1% vs. our forecast of 16.4%). Below-EBIT other expense was a drag of $0.06/sh (likely FX), while lower interest expense was a positive of ~$0.02/sh."

But despite what appears to be a pretty good quarter, margin concerns aside, Caterpillar really didn't trade well today. While initially surging in pre-market trade to past $98.00, Cat fell back prior to the open, making an intraday high of only 97.79. The rest of the day the stock traded about 1% above the prior day's closing. The stock closed out the day at 96.63, 0.88% above the prior day's close and below the opening of 97.10. Despite a strong quarter, the stock closed significantly below the highs and below the opening. Not a good sign.

I believe today's trading action signifies a tired trade in Caterpillar. Investors would appear to have taken the opportunity to take profits on good news, rather than continuing to buy CAT higher. Perhaps they fear that Caterpillar removed the near-term upside catalyst with its strong report and upbeat forecast. Of course Cramer took the opportunity to cheer one of his favorite stocks after the close, but I am more concerned with how CAT traded today than any of that.

Today I bought the CAT Feb 95 Puts. And despite another one of our author's observations of good volume on the call-side, it was only on the put side where trading volumes exceeded open interest with 8,200 of the 95 puts traded against open interest of 6,000 and 2,300 of the 100 puts against 1,900 open interest. With futures down at this point in the overnight session and the likelihood that we trade back from 1,300 S&P, I feel very good about being short this high beta stock.

Disclosure: I am short CAT.

Additional disclosure: Short CAT through Feb 95 Puts