by Mark Bern, CPA CFA
Caterpillar (NYSE:CAT) is a great company that has a global footprint deriving 68% of sales from outside the U.S. and a dominant position in its industry. The company is the largest manufacturer of earthmoving equipment in the world serving markets including road building, mining, logging, agriculture, petroleum, and general construction. The company also produces internal combustion engines and lift trucks.
While the U.S. economy appears to be on a course to recovery if left alone, much of the world is facing either recession (Europe) or slower growth (emerging markets). Demand appears to be falling in some of the areas that CAT dominates. High commodity prices still seem to point to strong demand for ores, and people still need to eat.
However, the demand from emerging markets appears to be slowing more than anticipated by the dry bulk carriers as evidenced by the Baltic Dry Index (BDI). I realize that shipping capacity has increased, but only by about 1.5% during the rapid drop of the BDI of over 90%. You would think that if demand were increasing by 3% or more a year in the emerging markets, such a small increase in capacity wouldn't be enough to tank the BDI rates. Shippers are losing money in a big way. Demand from Europe will be down in 2012, which seems a certainty due to contracting economies there. All in all, the demand picture remains more murky than clear for the foreseeable future. There is an informative blog on the BDI here. Thus, for the short term, I would recommend caution of those considering new purchases of CAT stock.
The longer term picture is much clearer, and the dominant position of CAT paints a much brighter picture. Let's take a look at the numbers compared to the industry averages. CAT has a debt to capital ratio of 66%, which is far higher than the industry average of 34%. The company continues to make strategic purchases of smaller competitors and niche companies that tend to complement its products or geographic reach. Also, the company has a return on shareholders' equity (ROE) of about 33%, which is well above the industry average of 16.5%. The company has a return on total capital ratio of 13.5% compared to the industry average of 8.5%.
Taken together with the ROE we can see that CAT's management is putting the additional debt to good use and creating an above average return of its capital. The net margin for CAT is 8.3%, also above the average of 5.3% for the industry. The dividend is currently yielding only 1.6%, which is only slightly better than the industry average of about 1.3%. But the company does have a great track record of increasing the dividend over the last 18 consecutive years.
The current trailing price/earnings ratio stands at 15.4, which is on the high side of the historical average for CAT. The shares for CAT have experienced a nice rally since early fall of 2011, having risen from the low of $67.54 to a current price of about $112 (near the close on Wednesday, February 15, 2012). That is equal to an increase of about 66% in less than five months. Granted, the price had been depressed and offered a great value at the low, but today's price seems a little on the high side considering the uncertainties currently facing the global economy.
While CAT meets my requirements of being a dominant, well-managed company with significant future growth potential over the long term and industry beating metrics, I don't believe the value proposition warrants a buy right now. I believe the patient investor should wait for CAT to drop to a range of $90 - $94 before considering adding this great company to a portfolio.