In an earlier article, I presented a bullish case on construction equipment-maker Caterpillar (NYSE:CAT). Since then, shareholder value has gone up by 25.4%. Accordingly, it is now a critical time to re-examine the stock price and ask whether or not is at an inflection point and heading into lower growth. While I believe that the firm continues to be undervalued, I do not recommend opening a long position now due to the risk. The stock has a beta of 1.85 and serious concerns linger about margin constraints and supplier issues.
Competitor Deere & Company (NYSE:DE), in my view, has much more favorable risk/reward at the present moment. From a multiples perspective, it is considerably cheaper. It trades at a respective 11.8x and 9.5x past and forward earnings while offering a dividend yield of 2.1%. Caterpillar (CAT), on the other hand, trades at a respective 14.7x and 10.7x past and forward earnings - the high end of peers - while offering a dividend yield of 1.9%. At the same time, Caterpillar is less leveraged with net debt representing only 53.6% of market value versus 72.1% of market value for Deere.
At the fourth quarter earnings call, Deere's management noted stellar performance:
It was an excellent quarter which capped an exceptional year. Profits and sales were the highest ever for a fourth quarter. The improvement was broad based but led by Ag and turf. Our other divisions construction, forestry, and John Deere Financial had dramatically higher results as well. Deere’s performance for both the quarter and full year reflected strong customer demand for our products as well as the skillful execution of our business plans which are aimed at expanding our global competitive position.
During the year these plans moved ahead at an aggressive rate. We introduced an unprecedented number of products, announced plans for new factories in China, Brazil, and India and invested a record amount in future growth, well over $2 billion of spending for R&D and capital projects. For the year as a whole, John Deere registered its highest ever level of sales, earnings, and cash flow.
Going forward, Deere will benefit from shifting towards global construction equipment and agriculture. Entering emerging markets will hedge against domestic risk and drive strong growth. In the short-term, however, the company faces churn from being closely positioned to the Canadian and US markets. Notwithstanding increases to scale, inflationary inputs and production expenses will also limit margins. In 2011, gross margins were 23.6%, around 290 basis points lower than they were for Caterpillar.
Consensus estimates for Deere's EPS are that it will grow by 17.3% to $7.78 in 2012 and then by 6.6% and 2.5% in the following years. Of the 22 revisions to estimates, all have gone up for a net change of 9.3%. Assuming a multiple of 13x and a conservative 2012 EPS estimate of $8.29, the rough intrinsic value of the stock is $106.86. This implies a margin of safety of 36.8% and is at the level that I consider to call the company a value play.
Caterpillar, however, has closed much of its discount to intrinsic value. The main catalysts for the firm is integration of Bucyrus, expansion of geographical footprint, improving capacity, and demand normalization. While since the same time last year, coal exports have gone up by almost 50%, this market makes up only around a twentieth of Caterpillar's sales. Growth in retail - led by North America - was 31% y-o-y in October, the same as it was in September. Engine sales accelerated slightly to 13% y-o-y in October.
Consensus estimates for Caterpillar's EPS are that it will grow by 63.6% to $6.79 in 2012 and then by 33% and 17.3% more in the following two years. Assuming a multiple of 13x and a conservative 2013 EPS of $8.29, the rough intrinsic value of the stock is $106.86. This implies a margin of safety of 22.1% and is not at the level that I consider to call the company a value play.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.