Why Cramer calls this stock "The Best Dog of the Dow"?
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Caterpillar (NYSE: CAT) investors were extremely delighted when they heard the company announcing that its global sales rose by 5%, marking the 30th straight three-month period of retail-sales expansion for this economic bellwether. But bullish and bearish investors both retain different takes about how the company will fare in the future.
The bears believe that the investors seem to ignore the way Caterpillar's growth rate has been easing in recent months. Apart from that, the bears are also concerned about the company’s massive inventory in North America and its slower-than-expected growth in China.
On the other hand, the bulls believe that fears regarding the U.S. presidental election and the fiscal cliff have subsided, and that retail sales may experience a total turnaround in North America. In this scenario, they also believe that other major players in the machinery industry are also poised to benefit from the improving market sentiment in the U.S.. Moreover, the bulls are also excited about Caterpillar's bright future in Latin America.
Retail Sales Summary
The following chart tells us a lot about the global macro environment:
Source: Caterpillar 8-K
It is important to compare this table with CAT’s revenue geography -- the proportion of Caterpillar's revenue made in different geographical areas.
The chart shows us that North America accounts for the largest portion of the revenue pie. However, it is disappointing to see that the growth rate of retail sales in North America has sharply declined from 13% to just 3%.
However, the sentiment around the macro environment is improving. Election fears have subsided, and our collective avoidance of the fiscal cliff should also help to stimulate equipment demand. An article published in the Wall Street Journal stated the following:
“The demand for the equipment built by Caterpillar Inc., Deere & Co. (NYSE: DE), Paccar Inc. (NASDAQ: PCAR) and other manufacturers could receive a bounce from tax increase legislation that many view as a wet blanket for U.S. economic growth. The bill includes a one-year extension of the accelerated depreciation program that allows companies to deduct up to 50% of the cost of capital equipment from their federal taxes. A 100% depreciation provision was in place until the end of 2011. The program was scheduled to expire at 2012's end before receiving a reprieve. The bonus depreciation program is credited with stimulating demand for capital equipment, as companies opted to use equipment purchases as a tax shield.”
The bears have their point to make as well. They state that the company has excessive inventories in North America. This inventory in the supply chain needs to be liquidated. A slower-than-expected growth rate in the retail sales could force the company to cut production more sharply -- a reduction that could extend well into 2013 and beyond.
The Asia/Pacific region seems like another area of concern. Caterpillar has solid plans to go massive in China. Currently, only 3% of the company’s revenues come from this region. However, the company wants to become as big as the local Chinese players like Sany Heavy Equipment (NASDAQOTH:SNYYY) or big Japanese players like Hitachi Limited (NASDAQOTH:HTHIY). IMF predicts a growth of 8.2% in the Chinese GDP. However, many factors are at play to decide whether this target will be achieved or not. The recent surge in the Chinese Purchasing Manager Index (PMI) has sent bullish signals to the market.
Growth in Latin America seems promising. The sales in Latin America continued to improve from recent months. November-period sales rose 15%, following 9% growth in October sales and a 4% contraction during September.
As already mentioned in the executive summary in the introduction, there are some other players in the machinery industry, as well, that are set to benefit from the improving market sentiment. In this context, Deere and Joy Global (NYSE: JOY) need a special mention.
Deere & Co.
This farming equipment company reported record sales and profits for its fiscal year ended Oct. 31, despite the worst drought for North American farmers in decades. The drought destroyed crops, but simultaneously led to a sharp increase in the crop prices, which led to a rise in the farmers’ incomes. The company gets 52% of its revenues from North America. This means that along with a rise in the farmers' income, the company is also expected to benefit from the improving market sentiment in the U.S. Along with the growth in North America, the company also expects firm growth in Latin America where the farms are booming and Deere has invested heavily in new product launches, factories and dealers.
The main concern that investors have about Joy Global is that this company derives more than 30% of its revenues by selling machinery used in mining coal. The shale gas boom has brought a secular decline in coal usage and therefore has severely damaged the company’s revenue growth rate.
However, it is important to note that the company gets 55% of its revenues from outside North America. This means that the company can still benefit from the rising usage of coal in different regions of the world like China.
Also, the company has a strong aftermarket service segment that helps it to derive almost 50% of its total revenues. Given that the company gets 45% of its revenues from North America, it is also expected to benefit from the fiscal cliff aversion through the bonus depreciation program and the stimulating demand for the capital equipment.
The firm has strong margins as compared to its peers, and the One Global Program being currently implemented in Joy will help the company to control costs in a more appropriate manner.
Fiscal cliff aversion is definitely going to help Caterpillar and other equipment makers that have large revenue bases in the U.S. However, holistically speaking, the global macro environment remains pretty much uncertain. Keep a close eye on heavy equipment makers' upcoming earnings reports for a better idea of how Caterpillar and its sector's future may play out.
AnalystX has no position in any stocks mentioned. The Motley Fool recommends Paccar. The Motley Fool owns shares of Joy Global, Inc. and Paccar. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!