An uncertain global macro environment has resulted in the markets valuing Caterpillar Inc. (NYSE:CAT) at only 10 times its trailing earnings, even though the company had a very good quarter in its most recent report (for the third quarter of 2012). Specifically, revenue was up 5% from the third quarter of 2011. Pretax income increased by 50%, and even after correcting for the difference in some secondary operating costs- Caterpillar actually generated income from these sources in Q3 2012, which we assume isn’t normal- it was up by 19%. Growth was led by the resource industries segment, which grew its operating income by 49%; there was also growth in power systems, which was the largest division in terms of revenue. There was a moderate decline in profitability in the construction segment.
The markets see Caterpillar Inc. as being threatened by potential weakness in China and the rest of the developing world, which would reduce demand for construction equipment directly and would also reduce demand for mining equipment as commodities booms cool. The stock’s beta is 1.9, demonstrating how dependent Caterpillar is on broader economic conditions, though the stock is actually down in the last year while the S&P 500 is up 15%.
Hedge funds weren’t very excited about Caterpillar Inc. either, possibly because of these macro concerns. The largest position in Caterpillar out of the funds and other notable investors in our database of 13F filings belonged to the Bill and Melinda Gates Foundation Trust; at 10.3 million shares, Caterpillar was one of the five largest positions in the trust’s portfolio (see what other stocks the trust is invested in). The only other filers to have more than $40 million invested in the equity- a fairly low threshold- were Phil Gross and Robert Atchinson’s Adage Capital Management and Donald Chiboucis’s Columbus Circle Investors. Find more stock picks from Adage Capital Management and from Columbus Circle Investors. While billionaire Steve Cohen’s SAC Capital Advisors did have a small position, the fund had sold 90% of the shares it had owned three months earlier (check out more of Cohen’s trades).
Sell-side analysts acknowledge these concerns and actually expect lower earnings in 2013, as shown by the forward P/E of 11. However, they are more optimistic about the long term: the five-year PEG ratio is only 0.7.
Caterpillar might actually be a good value, what about similar companies?
Caterpillar’s peers include CNH Global NV (NYSE:CNH), Joy Global Inc. (NYSE:JOY), and Deere & Company (NYSE:DE). The market is cautious on these companies as well, with CNH and Joy having betas more than 2 and each trading at only 9 times trailing earnings. This is so even though earnings were up by about 20% in their most recent quarterly report versus a year earlier. Deere is tied to the agriculture industry and so its multiples tend to be only slightly higher; for example, its forward P/E is 10. It has also been improving on both top and bottom lines. As a result there’s a case to be made that even if Caterpillar is cheap one or more of these peers are cheaper.
We can also compare Caterpillar to Freeport-McMoRan Copper & Gold Inc. (NYSE:FCX), which is also seen as a barometer of global economic conditions. Freeport-McMoRan recently dropped in price after it made two acquisitions in oil and gas, which we worry has the potential to weaken management’s focus in addition to possibly being done at too high a premium. Read more about the acquisitions and see which billionaire liked the deal. Its forward P/E is only 8. It’s possible that the market has overreacted, but we still worry about the effects of the company’s acquisitions and so we’d avoid the stock.
We like Caterpillar as a long term investment, and even in the short term we’re not sure that the market should be assuming that conditions will be so poor. We would be interested in taking a look at the company’s peers, however, to see if they are better buys.
