This is what an opportunity to buy Caterpillar (CAT) at a decent multiple is going to look like. The stock is selling off on what were actually solid Q1 results due in large part to fears tied to emerging market growth (especially China). While there are indeed relevant long-term risks that apply to Caterpillar, the global outlook for mining and construction equipment is pretty promising unless you subscribe to the idea that another global recession is on the way (in which case few stocks are going to outperform).
Good Operating Performance In Q1
Caterpillar did miss on the top line this quarter, but the miss was not all that large (apart from a few very aggressive sell-side analysts). Equipment revenue rose 25% on a 13% increase in volume and a better than 2% increase in price. Growth was strongest in the Resources business (up 73% reported, up about 36% organically), while Construction was okay (up 13% organically) and Power was the laggard at 9.1% growth.
Just as notable was the quality of Caterpillar's earnings. Gross margin ticked up a bit, while tight expense management underpinned a 28% rise in operating income and half-point improvement in operating margin.
China The Known Problem, But What Brazil?
Investors seem to be reacting badly to management's comments that business in China has been softer than expected since the Chinese New Year holiday, and that the overall machinery market could decline this year. While that's a serious development for companies like Joy Global (JOY), Komatsu (KMTUY.PK), and Volvo (VOLVY.PK) that look to China's machinery market for growth, it's not exactly a stunning development.
What I find more interesting (and less reported) was the fact that CAT's sales to Latin America were up just 6% this quarter. One would think that the energy and construction boom in Brazil would be fueling better results, and I'll be curious to see what other companies like Deere (DE), Cummins (CMI) have to say, particularly as Eaton (ETN) also signaled weakness in Brazil. It's worth noting, though, that most of these companies are actively building production facilities in China and Brazil - they're in it for the long term and short-term wobbles are not going to really impact the multi-year growth story.
Gives And Takes Across The Board
Although growth from the Europe/Africa/Mideast segment was surprisingly strong (and helped by energy/construction projects across the Mideast), North America is still the biggest growth engine in the heavy equipment/industrial space right now.
That's not to say that it's a simple market. Agricultural demand seems to be holding up well (not really a major factor Caterpillar), but the pick up in non-residential construction looks very erratic. While some may worry that declining utility coal demand will hurt Caterpillar's mining business, the company stands to benefit from construction activity related to natural gas infrastructure and additional sales of gas-fueled engines and turbines.
The Bottom Line
Even with the stock off its highs, I'm a little cautious about jumping in today. After all, investors are still baking in improvements in sustainable free cash flow generation that seem aggressive given Caterpillar's history. Yes, the company now has much more mining exposure and there are likely many years left in the global commodity boom, to say nothing of an eventual recovery in construction and infrastructure spending - it's just that "it's different this time" is a scary phrase with any cyclical story.
That said, I do like buying stories like Caterpillar when the stock hits a speed bump. Terex (TEX) and Manitowoc (MTW) arguably offer more leverage to a North American construction recovery and Atlas Copco remains an interesting European recovery play, but Caterpillar and Cummins look like stronger overall stories for the coming years. This emerging market-induced selling may be a gift for patient investors, but I would suggest letting things calm down just a bit before diving into the stock.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
