After 2008 and into 2009 when the U.S. and eurozone experienced a recession, Caterpillar's (CAT) net income dropped. In 2009, it dropped 75% to $895 million, while sales dropped 37% to $32 million. Since the 1930s, it has not seen a drop like this. But at the same time, through cost-cutting measures like many companies have taken, the company has seen earnings grow. Since 2010, there has been only one quarter in which the company did not top earnings estimates. And in 2011, net income rose to $4.9 billion, with $60 billion in sales. Caterpillar is where it is because of excellent foresight.
Diversity through Acquisition
Industry diversity is an important strategy when a company is looking to keep sales up. If a business sells one or two products and that industry slows down, so does sales. But diversification keeps sales steady. One strategy some larger businesses use is diversification through acquisition. This is one of the tactics of Caterpillar. Take a look at these four acquisitions:
- The company completed its $8.6 billion purchase of mining equipment maker Bucyrus International Inc. in July, its largest acquisition.
- It expects to complete the purchase of Hong Kong-based ERA Mining Machinery Ltd. (8043) in the third quarter, adding underground coal-mining equipment.
- It acquired German engine manufacturer Motoren-Werke Mannheim Holding GmbH in November for 580 million euros ($724 million).
- In August 2010, completed a $820 million purchase of locomotive manufacturer Electro-Motive Diesel Inc.
This diversifies and creates a wider variety in Caterpillar's product line from electricity generators for vacation homes to 100-ton trucks used at open-pit mines. Diversification through acquisition is a balanced strategy that the company has a huge grasp on, as it positions itself for business "after the economic slump."
The Strategy Really Works
The success of "diversity through acquisition" can be seen in real numbers when one looks at Caterpillar's sales record. North America used to be 50% of the company's sales, but last it accounted for just 36%. The rest of the global regions are well balanced. Asia-Pacific accounts for 25%; Europe, Africa, and the Middle East account for the rest. Between the developed and under developed world, sales were 50-50 last year. This is good balance and diversity.
I expect the stock to take a turn upward soon. I cannot tell how long it will take to move, but we certainly can take advantage of the signs it shows to create an income opportunity.
The Options Play
Currently trading at around 83.71, Caterpillar has a very prevalent positive divergence going in the RSI indicator after its long bearish drop. I am not sure if I can say that a new cycle will turn it bearish, but the divergence does show weakness in the downward trend. So I will position myself for an upward move in the future with good time decay protection and buying (ITM) on my first option with a Bull Call Spread.
- Buy a November 2012 call with a strike of '82.50' (priced at $7.50)
- Sell a November 2012 call with a strike of '85.00' (priced at $6.00)
- Net Debit to Start: $1.50
- Maximum Profit: $1.00
- Maximum Risk: net debit
- Maximum Length of Trade: 5 months
Reasoning behind the Trade
- Weakness in the downward trend is pronounced. This could signal a short-term bullish move.
- It is well diversified in sales with its acquisitions and I do not believe it will have trouble adjusting to slower sales in some regions.