This DOW Component Is a Deep Value Stock!

Anindya is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

ISI Group has recently upgraded Caterpillar (NYSE: CAT) from Hold to Buy with a price target of $111. The company's equipment sales improved 23% in 2012 from the prior year. With the ongoing macroeconomic recovery, demand for machinery and equipment is rising. Caterpillar, being the leader in the sector, is expected to outperform its rivals. The stock is expected to deliver a stellar performance in 2013.

Machinery Sector Outlook for 2013

According to the World Economic Outlook published by IMF, the world economy is expected to grow roughly 3.9% in 2013. Growth in advanced economies is projected at 1.9% in 2013, while it is anticipated that the emerging and developing countries would grow by 5.9% in 2013. 

Demand for the machinery industry is correlated with increasing economic activity, which stimulates demand for industrial products, thereby increasing the need for new/advanced machinery. The major end-markets for the machinery industry include agriculture, construction, mining and energy industries, among others. 

The machinery sector in specific and the broader factory sector in general have been doing reasonably well during the economic recovery. While momentum seems to be flagging a bit recently, the group's growth performance has been one of the best in the economy, according to IMF. 

Stimulus Packages will help Growing the Machinery Sector

  • China has announced a structural stimulus package in 2012. This will lead to construction of low-cost housing and completion of infrastructure projects on agriculture, forestry and water resources. 
  • In the United States, Congress announced a stimulus package in 2009 that has money flowing into infrastructure spending to fund roads, bridges and highway projects. 
  • Russia becoming the World Trade Organization (WTO) member in 2012 will open the gates for companies worldwide to benefit from the growing needs for modernizing the agricultural, transport and infrastructure sectors of the economy. 

Growth Catalysts for Caterpillar

Emerging Markets: Caterpillar's primary growth driver will be the emerging markets. The company estimates that Chinese infrastructure needs are going to be enormous in the next few years. Caterpillar's strategy in the emerging markets continues to succeed as they grew sales by more than 50% in Asia and Latin America between 2010 and 2012.

Caterpillar’s Economies of Scale: The company operates at a favorable economies of scale and is able to produce goods and services at prices that local competitors may not be able to compete at. Their intellectual property rights make them well-positioned in foreign markets.

High Standard of Products and Services: Caterpillar's dominance in the machinery space is the result of their high product and service quality. Countries across the world will continue to rely on Caterpillar's machines to build and maintain their bridges, roads and other infrastructure facilities.

Caterpillar: Trading in Deep Value Zone

Caterpillar’s ROIC (return on invested capital) has been rising steadily since 2010, due to their greater efficiency in deploying capital and the favorable economies of scale they enjoy. Other top players like Deere & Company (NYSE: DE) and CNH Global (NYSE: CNH) are lagging far behind Caterpillar on the capital front. 

<img src="" />

CAT Return on Invested Capital data by YCharts

R&D costs are on the rise for machine makers in their pursuit of manufacturing more sophisticated and technologically advanced machinery. Availability of funds remains difficult as some major nations are still struggling to bring stability to their own economies. As a result the FCF (free cash flow) position has been deteriorating for most of the companies in the sector. 

<img src="" />

CAT Free Cash Flow TTM data by YCharts

Caterpillar’s revenue per share has been more impressive than Deere & Company and CNH Global. With rising ROIC, Caterpillar’s robust revenue growth will help recovering the FCF position faster than the other two companies. The DJIA index has an average PE of 13. With a PE multiple of 9.7, this DOW component is trading at a significant discount in the index. 

<img src="" />

CAT Revenue Per Share TTM data by YCharts

Conclusion: Prospects Bright for Caterpillar

Rising needs of better infrastructure and modernized agricultural, manufacturing and mining methods will boost the demand for advanced capital intensive techniques worldwide. Caterpillar will certainly enjoy a comparative advantage among its competitors. 

Anindya7 has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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!

blog comments powered by Disqus