Will This Manufacturer Recover From its Tumble?
Lior is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Shares of Caterpillar (NYSE: CAT) have yet to recover from their tumble between April and June despite their rally in recent weeks. Some of this fall could be attributed to the decline in the stock market and the bearish market sentiment. But the sharp fall in Caterpillar's stock might suggest concerns for the future growth of the company. The recent financial reports for the second quarter of 2012 revealed a slight decline in the profit before income taxes compared to Q2 2011, and only a modest growth compared to Q1 2012. Let’s examine the Caterpillar financial situation and figure out will the recent rally continue? Will it be enough to pull back up the company’s stock?
The recent growth in Caterpillar’s stock could be partly attributed to certain macro changes and less to do with the company. The recent growth in the S&P500 is another indicator to a shift in market sentiment that is pulling up Caterpillar. The linear correlation between the S&P500 index and Caterpillar stock price reached 0.64 during August and September. This means that nearly 41% of the company’s stock volatility could be explained by the changes in S&P500. And yet, when comparing the progress of the S&P500 with that of Caterpillar's stock in the past several months, the stock of Caterpillar has underperformed. During the past several months (since April 2012) the S&P500 index remained nearly unchanged, while the company’s stock fell by nearly 18.5%.
The chart below presents the developments of S&P500 index and Caterpillar stock during 2012. The prices of normalized to the beginning of the April 2012. It also shows that in recent months both Caterpillar and S&P500 have risen by a small margin.
The recent growth in the price of oil is also one factor among others for the slow growth in Caterpillar’s stock. As I have pointed out in the past, the correlation between Caterpillar and price of oil has been mid-strong and positive. During the year, the linear correlation between the two reached 0.49, which means that nearly 25% of the company’s volatility could be explained by the shifts in oil prices. And according the company’s financial reports a rise in oil prices induces the demand for power systems (page 15):
“Worldwide demand for energy and higher oil prices are encouraging customers to invest, and we are seeing stronger demand for engines and turbines for petroleum applications”
During last month the price of oil rose by nearly 9.6%. This means that the recent the rally in oil prices might be among the factors to pull up the future demand for power systems and thus may have positively affected Caterpillar’s stock. Further, if oil price will continue to rise it may signal another modest rally in Caterpillar’s stock.
Despite the changes in the market, the bottom line will remain the future growth of Caterpillar and its financial results compared to its peers and competitors.
When comparing the performance of Caterpillar with other similar companies such as Cummins (NYSE: CMI) and Deere (NYSE: DE), one can see that Caterpillar was in the middle of the pack in recent quarters in terms of operating profitability. During the second quarter, the operating profitability of the Caterpillar was slightly higher than Deere and Cummins's operating profitability. Caterpillar's profitability also rose from the first to the second quarter. The chart below presents the development in the operating profitability of all three companies in the past four quarters. This means that Caterpillar has performed well in the past quarter in terms of profitability compared to related companies and yet the Caterpillar's stock has still underperformed in recent months.
In regards to Caterpillar’s growth there are still some reasons for cautious optimism: the power system industry, which represented nearly 33% of the company’s revenues in 2011, is still progressing and if oil prices will remain high, they are likely to help rally the demand in this industry.
In regards to the construction industry there are some conflicting signs in the U.S housing market: the number of new home sales rose last month. On the other hand, the housing starts edged down in July. If the U.S housing market won’t show some strong numbers, it is likely to indicate that the U.S housing market isn’t progressing which will curb the rally of Caterpillar. Perhaps the recent stimulus plan of the FOMC to purchase mortgage backed securities could help rally the housing market in the U.S.
The recent new plans of China to stimulate its economy by announcing a new infrastructure project worth more than $100 billion, is another factor to help Caterpillar’s growth in the construction industry.
The bottom line: there are some positive signs of growth for Caterpillar including the rise in the oil price, which could suggest Caterpillar will further rally. The company could continue its growth in Asia, mainly China, and other places such as South America, but the low growth in the U.S could curb the recovery of the company in the months to come which will make it harder to pull Caterpillar up from its tumble.
For further Reading see: Why Caterpillar isn’t pulling up? Just blame it on the Oil
Disclaimer: The author holds no positions in stocks mentioned and does not plan to initiate positions within 120 hours of the posting of this article. This article is to be used for educational, research and informational purposes only and does not constitute investment advice. There are no guarantees, expressed or implied, of future positive returns in regards to the subject matter contained herein. Understand the risks inherent in investing before making the decision to invest or consult an investment professional for more information. Reasonable due diligence has been performed in regards to the information in this article. However, the author expressly disclaims any liability for accidental omissions of information or errors in fact.
Dig Deeper
Caterpillar is the market share leader in an industry in which size matters, and its quality products, extensive service network, and unparalleled brand strength combine to give it solid competitive advantages. Read all about Caterpillar's strengths and weaknesses in the Fool’s brand new report. Just click here to access it now.
liorc 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.
