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For every kid who dreamed of making a living fooling around with monster trucks all day, Caterpillar Inc. (NYSE:CAT) offers a way to play with big boys' toys without even getting your hands dirty. It's not just about trucks any more though: Caterpillar is the world's leading manufacturer of construction, mining and forestry equipment, natural gas and diesel engines, locomotives and gas turbines. Wholly-owned subsidiaries and business support segments offer financial, remanufacturing, logistics and railroad services. If customers want to dig it, build it, tunnel it, fell it, transport it, drive it, overhaul it and even finance and insure it, they are reassured by the knowledge that Caterpillar has been doing much of this for more than 85 years.

During the Q3 earnings conference call, Mike DeWalt, Caterpillar's Director of Investor Relations, observed that sales and revenues rose in every geographic region, with the Europe/Africa/Middle East sector recording the highest rate of increase at +41%. The company's order backlog is 40% higher than it was a year ago. Non-manufacturing costs in the quarter rose only 6%, against a 31% sales increase. The 10-20% revenue increase forecast for 2012 persists in spite of an expected continuation of the weak US housing market and no new highway construction. Slow economic growth will allow some sectors of the business sufficient time to implement badly needed additional capacity. Each business sector has a 'tough' plan ready to go if times get really hard.

Caterpillar's greatest strengths are its size, durability and global presence. Yet this also means that it faces competition in every corner of the world. Regional competitors will often engage in short-term discounting to protect local markets, driving down Caterpillar's profit margin as it struggles to match prices. Global machinery manufacturing competitors include Komatsu, Volvo Construction Equipment, a part of the Volvo Group AB, CNH Global NV (NYSE:CNH), Deere & Co (NYSE:DE) and Hitachi Construction Machinery. Engine manufacturing competition comes from the likes of Cummins (NYSE:CMI), GE Energy Infrastructure, owned by General Electric (NYSE:GE), and the Siemens Energy division of Siemens (SI).

With almost 122,000 full-time employees globally, and revenues well distributed throughout the world, it would be easy to assume that Caterpillar would be partially insulated from regional slowdowns in activity. Yet 2009 was a painful year for Caterpillar, after stellar results in 2008. Operating profit fell to a dismal $577 million in 2009 (pdf), but in 2010 both revenues ($43 billion) and operating profit ($4 billion) staged a major recovery, hitting 83% and 89% of the high 2008 benchmark, respectively. The turnaround was based on improvement from 2009's low levels of machine demand in developed countries, bolstered by continuing economic growth in the developing world. A 2010 dividend of $1.74 per share set the seal on the 17th consecutive year of increasing dividends.

Caterpillar's 2011 results are therefore of particular interest to investors, keen to discover whether the recovery has been sustained and if the dividend record can be maintained for yet another year. Latest financials are for the third quarter, ended on September 30 2011. The good news is that, excluding the impact of a recent major acquisition, Q3 2011 was an all-time record quarter for both revenues and profit. More than 2,000 jobs were added during the quarter in the United States alone, 4,800 globally. The outlook for total 2011 is now $58 billion in revenue (up more than 35% on 2010) and a profit of around $6.75 per share. A further 10-20% revenue increase is forecast for 2012.

Machinery sales, currently around $55 billion, account for the bulk of annual revenue, and are fairly evenly distributed between the three main business segments of Construction, Resources and Power Systems. Financial Products revenue adds a relatively small but useful $2 to $3 billion.

During the Q3 earnings conference call, Mike DeWalt, Caterpillar's Director of Investor Relations, observed that sales and revenues rose in every geographic region, with the Europe/Africa/Middle East sector recording the highest rate of increase at +41%. The company's order backlog is 40% higher than it was a year ago. Non-manufacturing costs in the quarter rose only 6%, against a 31% sales increase. The 10-20% revenue increase forecast for 2012 persists in spite of an expected continuation of the weak US housing market and no new highway construction. Slow economic growth will allow some sectors of the business sufficient time to implement badly needed additional capacity. Each business sector has a 'tough' plan ready to go if times get really hard

So Caterpillar appears to have rebounded from the financial downturn in the short term, though it continues to be exposed to a weak economic recovery in the developed world, including continuing sovereign debt woes in Europe. Its management's forecasts are cautiously confident however, and negative aspects appear to have been already factored in. Construction, mining and power generation are likely to continue expanding in the Asia Pacific region in the near future, though perhaps at a slower rate than previously.

Caterpillar's stock has been on quite a roller coaster ride over the last year with the previous resistance level around the $114 price range as shown below:


(Click to enlarge)

Caterpillar's stock price is currently near its previous resistance level, so it will be interesting to observe whether the stock breaks resistance this time or takes another fall as it has three times previously over the previous year.

With Caterpillar's upcoming earnings release on Thursday, January 26, 2012, an investor in Caterpillar might consider entering a collar in order to provide some protection in case the company releases some bad news. A collar may be entered by selling a call option against the stock and using some of the proceeds from selling the call option to purchase a protective put option.

Using PowerOptions tools, a collar was found for Caterpillar with a potential profit of 2% and a maximum potential loss of 7.7%. The time frame for realizing the potential profit is 26 days. The specific call option to sell is the 2012 Feb 105 at $3.95 and the put option to purchase is the 2012 Feb 95 at $0.52. If the price of Caterpillar's stock is greater than or equal to the $105 strike price of the call option at options expiration in February, the position will return a profit of 2%. A profit/loss graph for the collar position is shown below:

If the price of Caterpillar's stock drops below $95, as it has previously over the last year, the value of the collar position remains the same due to the protective put option and the maximum potential loss is set at 7.7%.

Source: Protecting Caterpillar's Position