Why Investors Should Sell The Rally In Caterpillar And Buy Back At Around $80

| About: Caterpillar Inc. (CAT)
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Caterpillar Inc. (NYSE:CAT) is one of the world's largest makers of heavy equipment. This includes machinery made for use in the agricultural, mining, industrial and construction sectors. While many investors seem attracted to this company as an investment, it is important to separate an appreciation for this familiar brand and its cool products, with the fundamental challenges facing this company in terms of the global economy. In recent weeks, the stock dropped to about $80 per share, but it has since rallied back to $90. I see a couple of company-specific reasons why investors might be rewarded for selling now and patiently waiting for a better buying opportunity. There are also some macro-economic issues why Caterpillar shares could drift lower.

Many of Caterpillar's most important markets are seeing what appears to be a marked slowdown. Europe is still roiled in a debt crisis, there are new signs of weakness in the United States and there is a looming "fiscal cliff" issue at the end of 2012. Furthermore, China is seeing a slowdown, and some believe that could turn into something far more serious in the future. A recent Bloomberg article summarizes the risk of a economic slowdown in China and it states:

China is entering a "danger zone" where a financial crisis may become more likely because of increases in loans and property prices coinciding with an aging of the population, a Bank of Japan official said. "If a demographic change, a property-price bubble, and a steep increase in loans coincide, then a financial crisis seems more likely," BOJ Deputy Governor Kiyohiko Nishimura said in a speech for a conference in Sydney, posted on the central bank's website today. "And China is now entering the danger zone."

In terms of the U.S. economy and stock market outlook, analysis from Goldman Sachs (NYSE:GS) paints a strong case for selling stocks now, with the belief that the "fiscal cliff" issue could roil markets in the coming months. I think investors are far too complacent about the fiscal cliff, whereby the U.S. Government is poised to implement across-the-board budget cuts, and just around the same time raise taxes. This is also known as austerity in many European countries, and those that have recently raised taxes and cut government spending have seen devastating drops in economic activity. Just take a look at Greece and Spain for examples of what a "fiscal cliff" might do to our economy.

As for the company-specific issues, my concern is primarily about the balance sheet. Caterpillar has about $2.82 billion in cash and around $39.32 billion in debt. That is a significant debt load to carry, even in a strong economy, but in an economy that has the potential for continued global weakness, this leverage could turn into a real weight on profitability and the stock price.

Caterpillar is an economically-sensitive company, and at about 10 times earnings, it does not appear to be the best value in the market. Other companies that are sensitive to economic cycles, like the auto sector, appear to be much cheaper. Both General Motors (NYSE:GM) and Ford (NYSE:F), trade for just about 6 times earnings. Plus, GM has a stronger balance sheet, with about $32.6 billion in cash and just $14.79 billion in debt.

Even Jim Cramer, a former bull on this stock, is now "backing away". With many challenges facing the global economy, the upside appears limited, but the downside risks could be significant. That's why patient investors should wait for a buying opportunity at about $80 per share, or less.

Key Data Points For Caterpillar:

  • Current Share Price: $90.29
  • 52-Week Range: $67.54 to $116.95
  • Dividend: $2.08 per share, which yields 2.4%
  • 2012 Earnings Estimate: $9.61 per share
  • 2013 Earnings Estimate: $10.52 per share
  • P/E Ratio: about 10 times earnings

Data is sourced from Yahoo Finance.

Disclosure: I am long F, GM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Disclaimer: No guarantees or representations are made. Please consult a financial advisor before making investments.