Caterpillar (NYSE:CAT) is a heavy equipment manufacturer selling machinery, engines and industrial turbines through a worldwide dealer network. In recent years CAT has added to its core manufacturing portfolio by selling financial and insurance solutions. The company has a strong positioning in the mining industry by manufacturing specialized high-in-demand equipment such as loaders, handlers, graders and excavators. CAT is a DJIA S&P 500 company and has a market capitalization of $53.50 billion.
I like about Caterpillar that it has almost 90 years of heavy machinery and engine manufacturing experience, which incorporates huge levels of technological know-how. Caterpillar is selling its products in more than 180 countries and has a portfolio of over 300 products, many of them carry the "CAT" name, which I consider to be the core brand of Caterpillar's brand portfolio. Caterpillar describes itself at the "world's leading manufacturer of construction and mining equipment, diesel and natural gas engines, industrial gas turbines and diesel-electric locomotives" and had sales of $60 billion in 2011.
More importantly, Caterpillar can translate its engineering and design competence into tangible economic results: The company has strong operating cash flow of $6.6 billion and a high return on equity of 37%. Given a strong product portfolio, decades-long engineering and manufacturing experience and great profitability, why does Caterpillar lag the market by over 25% over the last 52 weeks?
Well, there are a couple of reason for CAT's under performance over recent months. With a heavy focus on the mining and resource industry, CAT is highly dependent on global growth and resource exploration activities. A profit warning from Cummins (NYSE:CMI), a CAT competitor, that indicated weaker order trends in the U.S., Latin America and China, sent manufacturing stocks downward. Worries about the the drought in the Midwest of the U.S. had an impact on another CAT competitor, Deere & company (NYSE:DE), which is set to take a hit with lower tractor sales. In addition, generally perceived weak U.S. and Chinese economies also sent bearish signals to investors. Investors should know that CAT is a cyclical commodity play. However, it is a very attractive one: The P/E ratio stands at a ridiculous 7.3 and the company pays a dividend of 2.5%.
Analysts estimate a 2013 EPS of $11, which is in line with my expectations. I am convinced that a market leader in heavy manufacturing with clients in 180 countries, that has been around for nearly 90 years and achieves superior results, can reasonably trade at 15x forward earnings. Given the average EPS estimate of $11, the conservative intrinsic value of Caterpillar stands at $165 - marking about 100% upside in a more or less conservative scenario. I also believe that this intrinsic value underestimates the long-term earnings power of Caterpillar as growth going forward is likely to increase on average as the U.S., England and Europe are still weak.
Caterpillar has a 52-week trading range of $67.54-116.95 and is down about 9% year to date despite great performance in Q1. Research house Longbow recently (mid April) upgraded CAT to Buy with a price target of $132 - marking an upside potential of over 60%.
Investors, who want to participate in the exploration of critical commodities could do well over the course of an entire business cycle with a Caterpillar investment. Savvy investors buy stocks when they are on sale. Given the superior business quality of CAT and its earnings multiple of 7.3, I could imagine the stock to double over the course of 2-3 years as economic conditions improve. A worsening of economic conditions, however, is equally likely to affect the company. In this case, investors might find a stop loss limit at $74 (below the lower bound of the trend canal) a reasonable insurance strategy against unanticipated setbacks.