Although many are worried about budget cuts in infrastructure, I still find reasons to be optimistic about construction companies. In this article, I will run you through my DCF model on Caterpillar (CAT) and then triangulate the result with a review of the fundamentals against Deere (DE) and Manitowoc (MTW). I find that, while Caterpillar isn't trading below intrinsic value, some exposure to the industry is still worthwhile.
First, let's start with an assumption about the top-line. Caterpillar finished FY2011 with $60.1B in revenue, which represented a 41.2% gain off of the preceding year. I model a 17.5% per annum growth rate over the next half decade or so.
Moving onto the cost-side of the equation, there are several items to consider: operating expenses, capital expenditures, and taxes. I model cost of goods sold as 73.6% of revenue versus 9.5% for SG&A, 4.1% for R&D, and 6.7% for capex. Taxes are estimated at 26% of adjusted EBIT (ie. excluding non-cash depreciation charges to keep this a pure operating model.)
We then need to subtract out net increases in working capital to get free cash. I estimate this figure hovering around -1% of revenue over the explicitly projected time period.
Taking a perpetual growth rate of 2.5% and discounting backwards by a WACC of 9% yields a fair value figure of $103.54, implying 5.2% upside.
All of this falls within the context of strong operating performance:
"This morning we were pleased to report our first quarter 2012 financial results, kicking off the year with the highest profit of any quarter in history. Sales and revenues were $16 billion, an increase of 23% from the first quarter of 2011, and excluding acquisitions of Bucyrus and MWM, which we didn't own a year ago in the first quarter, excluding them, sales and revenues were up about 15%.
Again, profit in the quarter was $2.37, the highest in history, and up 29% from the first quarter a year ago. In addition to the record-breaking profit, this morning we announced an increase to our 2012 profit outlook".
From a multiples perspective, the story appears even brighter. The stock trades at a respective 12.4x and 8.6x past and forward earnings versus 12x and 9.6x for Deere and 39x and 8.4x for Manitowoc.
Consensus estimates for Deere's EPS forecast that it will grow by 21% to $8.02 in 2012 and then by 6.1% and 4% in the following two years. Assuming a multiple of 16x and a conservative 2013 EPS of $5.45, the stock would hit $87.20 for 8.1% upside. Deere is more than 60% volatile than the broader market but is nevertheless led by top management. As the firm is the leader in agriculture and foresting equipment, it also has relatively stable streams of free cash flow. The firm also remains discounted due to concerns over housing - when this negativity dissipates, the firm is well positioned to realize multiples expansion.
Manitowoc recently missed 1Q12 expectations by $0.09 with quarterly EPS of $0.01. Sales nevertheless grew 18% from the preceding quarter while debt reduction trends look good. The firm is on track to clearing off upwards of $200M in leverage from the balance sheet for FY2012, which will reduce volatility and therefore bring down the discount rate and create value. Despite disappointing results, management has reiterated guidance: 10-15% y-o-y EBIT growth and 10-15% y-o-y revenue growth in Cranes. Uneven demand may have put some investors on the sidelines, but the secular trends remain strong.
Additional disclosure: We seek IR business from all of the firms in our coverage, but research covered in this note is independent and for prospective clients. The distributor of this research report, Gould Partners, manages Takeover Analyst and is not a licensed investment adviser or broker dealer. Investors are cautioned to perform their own due diligence.