On July 17th, famous short seller Jim Chanos of Kynikos (the short seller who played a key role in uncovering fraud at Enron and WorldCom) mentioned at the Delivering Alpha conference that he was short Caterpillar Inc. (NYSE:CAT) on its ties to mining, China (a known Chanos short thesis), and potential accounting issues. See Chanos’s most recent long stock picks. With demand for infrastructure and construction slowing down in China, commodity demand should fall, in his view; as a result, miners will invest less cash in capital expenditures (a key source of business for Caterpillar Inc. (NYSE:CAT)). In fact, Chanos argued that mining capital expenditures will collapse as opposed to the more moderate percentage declines expected by many analysts. Caterpillar Inc. (NYSE:CAT) fell about 2% on the day in response.
On the surface, Caterpillar Inc. (NYSE:CAT) seems like an aggressive pick for a short seller with a valuation of 12 times trailing earnings. However, the company’s recent results have not been good- revenue fell 17% in the first quarter of 2013 versus a year earlier, with net income down over 40%- and as we’ve mentioned Chanos’s thesis is that current mining cap ex numbers are not only unsustainable but about to plummet. Caterpillar Inc. (NYSE:CAT)’s Resource Industries segment did see a steeper decline in sales over this time frame, and profits for that segment were only about $480 million in Q1 2013 as opposed to $1.2 billion in the prior year period. Wall Street analysts expect the company to recover going forward, with EPS in the range of $8 in 2014 and beyond; Chanos thinks between $5 and $6 per share is more likely in the long term. With the current stock price being $86, that would leave quite a bit of downside if he proves correct.
Joy Global Inc. (NYSE:JOY) is another mining equipment company. Joy Global Inc. (NYSE:JOY) is in fact a somewhat popular short target, with 13% of the float held short, and it too has at least recently been experiencing significant declines in both revenue and net income. The stock trades at a considerable discount to Caterpillar Inc. (NYSE:CAT), at only 9 times forward earnings estimates, suggesting that the market has already priced in moderate declines in EPS at Joy Global Inc. (NYSE:JOY). The sell-side is optimistic here as well, and as a result the five-year PEG ratio is 0.9. Other farm, construction, and other equipment companies which can also be compared to Caterpillar include CNH Global NV (NYSE:CNH), Deere & Company (NYSE:DE), and Terex Corporation (NYSE:TEX). These three peers carry forward P/Es in the 9-10 range as well, and while they do have significant macro exposure they could be thought to be less dependent on mining as a source of business. Deere & Company (NYSE:DE) is the only one of these three companies that has been experiencing modest revenue growth, though there margins have been contracting a bit resulting in only 3% higher earnings in its most recent quarter compared to the same period in the previous fiscal year.
We’ve liked Caterpillar in the past, but more recently the company’s recent results have suggested potential trouble ahead even at its fairly low valuation. In addition, it is valued at a premium to its peers and by late June we’d recommended avoiding the stock. Chanos’s views on mining capex are also worth taking into account, and so selling Caterpillar or forming some kind of pair trade with an equipment company less exposed to mining may be wiser than owning it right now.
Disclosure: I own no shares of any stocks mentioned in this article.
