Andrés is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
The global economy is not going through the best times, and that has kept investors away from cyclical companies like Caterpillar(NYSE: CAT). But digging below the surface – pun intended – this global machinery powerhouse offers a lot of value and attractive growth prospects.
Trading at a P/E ratio of less than 10 times earnings from the past 12 months and yielding 2.5% in dividends, shares of Caterpillar are clearly cheap. The business is quite cyclical, and that exposes investors in Caterpillar to economic fluctuations to a high degree. But the company has been reporting strong numbers, which signal the possibility of exaggerated pessimism regarding the influence of macro issues on its financial performance, and the future looks quite exciting for this company in the middle term.
Caterpillar reported better than expected earnings last week, profit rose to a quarterly record of nearly $1.7 billion, or $2.54 per share; both figures are 67% above second-quarter 2011 results. Revenue rose 22% to a record $17.37 billion. Although management warned about the negative effects of weakness in Europe and rising inventories in China on its sales for the rest of the year, Caterpillar increased its earnings per share target to $9.6 from $9.5.
If the economy is taking a toll on the company, it doesn´t seem like a dramatically important one. The acquisition of Bucyrus is yielding positive results, as operating margins in the mining segment grew to 26.5% from 24.8% last year, and have climbed notoriously from the 15% range they had in the first months after the acquisition.
Although it will be facing strong competition in mining from companies like Joy Global(NYSE: JOY), which has sustained double digit growth rates in sales over the years due to both organic expansion and acquisitions, Caterpillar is making an auspicious entry into an industry with attractive long term potential.
Japanese competitor Komatsu(NASDAQOTH: KMTUF.PK) has increased its market share in China lately and is now bigger than Caterpillar in that high growth market. China will be a huge driver of demand for machinery equipment in the following years, and it is increasing its investments in the country to recover lost ground. Over the following quarters, however, China could be a drag on overall profitability as the company increases spending in a highly competitive market.
One of the most positive aspects for Caterpillar in the middle term is the expected recovery in US construction. The company has a rock solid position in that industry, and several indicators are pointing to improving conditions in construction over the last few months. Even if the recovery is slower than we would like, there is enormous room for improvement, since construction activity is still depressed in comparison to historical levels.
This exposure to construction puts Caterpillar in an advantaged place versus other machine manufacturers, like Deere(NYSE: DE) and CNH(NYSE: CNH), which have a much heavier focus on agribusiness. The agro sector has positive prospects in the long term due to rising demand from emerging markets, but the noteworthy increase in commodity prices recently has produced record levels of demand for machinery in the sector. It wouldn’t be a big surprise if we saw some bumps in growth over the middle term for these companies due to the cyclical nature of the industry.
Its attractive valuation and strong leadership position, combined with big upside potential in demand for construction over the middle term, make Caterpillar a high quality business offering a convenient entry price for long term investors who are willing to look below the surface in their search for the best investment opportunities.
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