Reconstruct Your Portfolio With This Stock

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JPMorgan cut its rating and price target for Caterpillar (NYSE: CAT) on Monday. Ann Duignan lowered her price target to $90 from $109 citing regulatory hurdles from the Obama administration and expectations of lower capital expenditures from mining companies.

Yet, for long-term investors, I believe the current headwinds have provided a good buying opportunity. With a stock price around the $85 level, I believe we’ve hit a trough, and it’s only a matter of time before the company returns to its previous highs in the $115 range.

As a cyclical stock, the company trades in step with the economies it has the most exposure too. Currently, those are the U.S. and China. Indeed, in the economic downturn in late 2008, Caterpillar shares fell nearly 75%. Now, with a slowdown in China, the stock is seeing another pullback.

The Outlook in China

Last week, the Chinese government released a report showing the economy is getting back on track. Exports grew to a five-month high, trade surplus reached its highest levels in nearly two years, but most importantly for Caterpillar, infrastructure investment is accelerating.

The government is making it easier for banks to loan money. It cut interest rates in both June and July and lowered bank reserve ratios three times since late 2011. Additionally, it is steadily injecting cash into the system while keeping an eye on inflation. That means easier access to money for infrastructure projects. In fact, in September the government sped up the approval process for infrastructure projects worth a total of $157 billion.

With new leadership in place, it is up to them to meet outgoing President Hu Jintao’s goal to double 2010 GDP by 2012. While Hu’s administration has been able to stave off a hard-landing, it is up to the new leadership of Xi Jinping and his administration to keep the economy growing. I expect the government to create another catalyst for economic growth, perhaps through more construction or mining, which could help Caterpillar’s prospects down the road.

The U.S. Still Builds Stuff

A large part of President Obama’s recovery plan for the United States is infrastructure and construction projects. Interestingly, Caterpillar has a 25% market share in the U.S. construction market.

The outlook for 2013 is very positive. New housing construction is expected to grow to near pre-recession levels with estimates reaching nearly 1 million net new housing projects. Pre-recession, we were constructing 1.1 to 1.4 million. However, the biggest potential for growth is in education, power generation, and highway construction where spending projects have been delayed, but are set to resume in 2013 and 2014. There’s also the Panama Canal expansion set to complete in 2015, in which Caterpillar is a major supplier.

So even with mining companies putting a lid on capital expenditures, there’s plenty of promise for Caterpillar in the future.

Valuation

Caterpillar trades at a forward P/E of just 9.37. This is a 37% discount from its historic P/E levels near 15. With expected growth over the next five years at 14%, this puts its PEG at a very attractive 0.67.

Comparables Deere (NYSE: DE), Terex Corp (NYSE: TEX), and CNH Global (NYSE: CNH) trade in a similar P/E range to Caterpillar between 8.5 and 10.5 times forward earnings. However, these companies are not expected to grow as quickly resulting in PEG ratios closer to 1.

While Caterpillar still sees its share price beaten down, all three of these comparables have seen their share price return to near 52-week high levels. The opportunity may have passed for those companies, but Caterpillar looks like it’s trading in its trough. Remember, these companies are very cyclical. It’s only a matter of time before construction work picks up again. I believe those days are closer than many people think.


adamlevy has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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