4 Catalysts To Push Caterpillar Higher

| About: Caterpillar Inc. (CAT)


Caterpillar could be set to benefit from a dovish Federal Reserve, with it having the scope to provide more beneficial interest rates and an improved outlook for domestic construction.

A brighter outlook for the commodity market and the subsequent investment by resources companies in machinery may also positively catalyze Caterpillar’s earnings.

With Caterpillar embarking on a major restructuring and cost-cutting drive, it could emerge as a leaner business which is better equipped to grow its earnings.

In the last year, Caterpillar's (NYSE: CAT) share price has fallen by 15% as the company has experienced falling profitability. This has weakened investor sentiment and with Caterpillar's most recent quarterly results showing a decline in EPS of 77.3% versus the first quarter of the previous financial year, this is of little surprise.

Despite this, we remain bullish regarding Caterpillar's prospects and believe that it will outperform the S&P 500 moving forward. A key reason for this is the increasingly dovish stance of the Federal Reserve, with them being much more cautious than previously expected regarding tightening monetary policy for fear of choking off the economic recovery.

We think this would be good news for Caterpillar and act as a positive catalyst on its share price due to its impact on the domestic construction industry. Lower interest rates mean that borrowing is less costly and this should help to keep the construction industry growing and demanding new machinery. In fact, Caterpillar's construction segment accounted for over 35% of its revenue in 2015 and so with there being the potential for robust performance from it due to low interest rates, it could have a major impact on Caterpillar's overall profitability and share price.

Lower than expected interest rates should also help Caterpillar's international sales. With the US dollar having previously strengthened due to the anticipation among investors that multiple interest rate rises were due in 2016, the lack of monetary policy tightening is likely to cause further weakness in the US dollar. This could provide a boost to Caterpillar's overall sales and profitability and act as a positive catalyst on its share price since sales outside of the US made up 27.6% of Caterpillar's total sales in 2015.

Of course, a key reason for Caterpillar's declining share price in the last year has been falling commodity prices. They have caused Caterpillar's financial performance to come under pressure, but in recent months there has been sustained rise in a range of commodities across the resources sector and the continuation of this trend has the potential to positively catalyze Caterpillar's profitability and share price.

That's because Caterpillar's resource segment accounted for 16.1% of its total sales in 2015, while the energy & transportation segment was the company's biggest segment last year, contributing 38.2% of its total revenue. Both of these segments are heavily dependent upon commodity prices because they mean that mining and other resources companies are more profitable and are better able to invest for long term growth through new and replacement machinery.

With commodity prices now being higher than in recent months and having the scope to rise further as the supply/demand imbalance naturally returns to equilibrium, Caterpillar's financial outlook has scope to improve and have a positive impact on its share price performance.

Another factor which could act as a positive catalyst on Caterpillar's share price moving forward is the major restructuring and cost-cutting programme on which it is currently engaged. Caterpillar reported in its most recent quarterly update that it was able to cut around $500m from its variable manufacturing costs versus the prior quarter and with the company due to invest around $550m in restructuring the business in the current year alone, it is likely to emerge as a leaner, more efficient and more profitable entity in the long run.

Further, Caterpillar is increasing the scale of its restructuring. For example, it has decided to end the production of on-highway vocational trucks as it seeks to improve long term cost savings. This should allow it to invest more heavily than it otherwise would in research and development and on its digital capabilities. Therefore, while restructuring and cost-cutting may be somewhat painful and costly in the short run, it could create a more streamlined business which is ultimately more profitable. As a result, we believe that continued investment in the business could act as a positive catalyst on Caterpillar's financial performance and on its share price.

So, while Caterpillar's shares have disappointed in the last year, we see a weaker US dollar, a dovish Fed's positive impact on US construction performance, a brighter future for commodity prices and an improved business following restructuring as the four key catalysts which will push Caterpillar's share price higher moving forward.

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