With large supply and low prices for natural gas, Caterpillar (CAT) has been getting a lot of interest in its natural gas reciprocating engines, as noted in the company's Q1 2012 earnings call held on April 25, 2012. The company's fairly recent acquisition (pdf) of MWM further strengthens Caterpillar's position with regard to natural gas, as MWM has more than 140 years of experience in the development of combustion engines for natural gas.
Even though the company appears positioned to take advantage of low natural gas prices, just reported its highest profit of any quarter in history and increased its 2012 profit outlook, Caterpillar's stock price has taken quite a fall as shown below:
Apparently, Caterpillar is getting dinged for slowed growth in China and the company's exposure to Europe, as Europe has been in quite a tizzy of late due to issues related to sovereign debt. The company reported sales related to China as being down $250 to $300 million and mostly related to excavators. In order to compensate, the company is moving some of its excess inventory from China to other regions with greater demand. Caterpillar expects Chinese related business to recover, but the timing for recovery is unclear. The company reported sales in Northern Europe were much better than Southern Europe, and, like China also expects European sales to recover at some point.
Caterpillar's stock price getting dinged could also be due to its competitors stock prices not doing so well, as the stock prices of Komatsu (KMTUY.PK), Deere & Company (DE) and CNH (CNH) have also been down recently.
In the most recent quarter, revenue came in at $16 billion and was up 23% year-over-year. Excluding the Bucyrus and MWM acquisitions, revenue was up 15% year-over-year. Construction related revenues were up 13% year-over-year. Resource industries revenue, of which the majority is related to mining, experienced a growth of 73% year-over-year, aided by the company's acquisition of Bucyrus (pdf). Even without the contribution of Bucyrus, resource industry related revenue grew at a very nice 36% clip. Coal related sales were a drag on resource industries, as the coal market segment has been negatively affected by the low prices for natural gas. The power systems segment, engines, turbines, rail, etc., reported 12% year-over-year growth. Organic growth for power systems was 9% year-over-year, as 3% of growth was attributed to the MWM acquisition.
Caterpillar expects a longer-term highway infrastructure bill in the U.S. following the upcoming elections, which should be good for business. With regard Caterpillar's increasing its profit outlook, the company increased its outlook for North America segment, but reduced its outlook with respect to the China and Brazil segments.
With Caterpillar's upcoming earnings release scheduled for July 25, 2012, and the company's upcoming dividend payment, an investor might consider entering a protected covered call or collar for the company, as a way to position for a potential profit and as a way to provide protection against a large drop in stock price. A protected covered call may be entered by selling a call option against a stock and using some of the proceeds to purchase a put option for protection or "stock insurance".
Using PowerOptions tools, a variety of protected covered call positions are available for Caterpillar as shown below:
The position with the highest potential return looks attractive with a potential return of 2.4% (7% annualized) and a maximum potential loss of 7.2%, so even if the stock price drops all the way to zero, the maximum loss which can be sustained is 7.2%. The 2.4% return does not take into consideration dividend payments during the holding time. The potential return, including dividend payments, is 3.7% (10.9% annualized) with a maximum potential loss of 6%. The specific call option to sell is the 2012 Nov 80 at $6.10 and the put option to purchase is the 2012 Nov 72.5 at $3.25.
- CAT stock (existing or purchased)
- Sell 2012 Nov 80 Call at $6.10
- Buy 2012 Nov 72.5 Put at $3.25
A profit/loss graph for one contract of the Caterpillar protected covered call, including dividend payments, is shown below:
For a stock price below the $72.5 strike price of the put option, the value of the protected covered call remains unchanged. If the price of the stock increases to around $90, the position can most likely be rolled in order to realize additional potential return.