Is it Time to Dig up Caterpillar?

By Ryan Guenette - August 15, 2012 | Tickers: CAT, CMI, DE, JOY, TEX | 0 Comments

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Over the past year Caterpillar (NYSE: CAT) has fallen 2.75%, vastly underperforming the S&P 500, which has rallied 16.8% over the same period. As Caterpillar manufactures and sells construction and mining equipment, diesel and natural gas engines, and industrial gas turbines and diesel-electric locomotives, the company is highly linked to economic environment conditions. Unsettling economic reports of China’s decelerating economy, as well as fears of the entire European Union falling into a recession have put the company's stock price on a crazy roller-coaster ride. Now as Caterpillar’s stock nears the unchanged mark for the year, is it time to dig Caterpillar up?

Underlying Business Is Still Strong

In 2008, Caterpillar reported earnings per share of $5.83. In 2014, the average analyst consensus believes Cat will derive $12.90 from its business operations. This presents a 121.27% increase in earnings per share over just 6 years. Based on these statistics, Caterpillar’s compound annual growth rate (CAGR) is 14.15%, an incredible feat for a company of such substantial size.

Through the colossal economic downturn of 2008, Cat still grew at an annualized rate in the double digits, displaying financial consistency. Additionally, the company pays out a rewarding dividend to its investors that acted as a security blanket to investors during steep economic downturns. Currently, Caterpillar pays out an annual dividend of $2.08, which at the current price puts Caterpillar’s dividend as yielding 2.34%. This is up from 2011’s annual dividend of $1.84, and is further expected to expand into the future. By 2014, the Street anticipates Cat’s dividend to reach $2.10. Additionally, the company has been paying out dividends since 1987, displaying the company’s dedication to its shareholders. From this we see the tremendous underlying strength of Caterpillar’s growth profile, as well as a reassuring dividend that has grown year after year.

The chart below displays Caterpillar’s sales, operating profit, net income, net margin, operating margin, earnings per share, dividend, and rate of dividend (the percentage of net income that is paid out in the dividend) over the foreseeable future.

Global Economic Outlook

Caterpillar is highly correlated to the global economic environment. With growth and prosperity comes a greater demand for the construction of new buildings and sites. Governments turn their focus to improving infrastructure and expanding in strong economic times. To build these buildings and repair bridges, roads, and other transportation platforms, the construction companies turn to Cat and other machinery companies to provide them with the proper tools.

In times of poverty and economic stagnation, there simply is no demand for the construction of new building and the repair of bridges, as there is simply no money left on the books to invest in the projects. In these times, Caterpillar does the best it can to make money, and sells its products to companies that absolutely require the machines. In conclusion, Caterpillar flourishes in times of expansion and withers in time of economic retraction.

According to the IMF, the long-term trend is in Caterpillar’s favor, as the world real GDP growth trend line from 1980 to 2014 rises from 2.67% in 1980, to a projected 4.10% in 2014. The only year of negative global GDP growth occurred in 2009, in the thick of the great recession. The chart below displays the world real GDP growth from 1980 to 2014, clearly displaying economic growth over the long term, which will benefit Caterpillar.

Who is the Meanest of the Machines?    

Compared to some of Caterpillar’s most prominent competitors, such as Deere & Company (NYSE: DE), Cummins Inc. (NYSE: CMI), Joy Global Inc. (NYSE: JOY), and Terex Corp. (NYSE: TEX), Caterpillar stacks up relatively in-line.

In terms of growth, Caterpillar stands in the middle of the road, while Cummins leads the industry. All companies in the industry pay out dividends except for Terex, with Caterpillar possessing the largest dividend, and Cummins possessing the fastest growing dividend. In the fundamental ratio comparison, Terex appears to be a little pricey, while Joy Global appears to be trading at a discount. When growth is taken into account all companies trade below the ideal ratio of 1, with Joy Global trading at the biggest discount. In the net profit margin comparison, Joy Global stands out to the upside, while Terex stands out to the downside.

The Foolish Bottom Line

The newspapers of the world are headed with warnings, projections, and guarantees that the global economic picture is blurring, worsening by the day. Yet the true picture displays a global economy with significant weaknesses, such as the United States and European Union, but major positive drivers, such as Latin America and China. According to the IMF, the world economic environment is stabilizing, not shrinking, and is set to continue to grow well into the future. If you believe in the global economy expanding over the long term, then Caterpillar is a perfect company. Cat is a global diversified company that flourishes in times of growth and struggles in times of economic downturn. Caterpillar is not for everyone, as it has price swings greater than other stocks, but is ideal for the long-term investors willing to take some short-term pain.         

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