Caterpillar still holds promise, even in mining slump

Global urbanization should do wonders for the stock's recovery.

By Benzinga Oct 29, 2013 12:05PM

Caterpillar equipment sits on a sales lot. © Orlin Wagner/APBy Jonathan Yates

Considering it's a member of the Dow Jones Industrial Average, Caterpillar (CAT) is a very volatile stock.

With a beta of 1.83, the price moves up and down almost twice as much as the stock market as a whole. For patient, long term investors, that price action provides opportunities to buy shares of the world's largest equipment maker at a discount.

Such a time is now, as Caterpillar just reported a 44 percent drop in earnings in its latest quarter, causing its share price to fall almost 3 percent for the week.

For growth, value, and income investors, there is much to like about Caterpillar for the long haul.

The company is down largely due to a slump in the global mining industry. Recovery from the Great Recession still has not been enough to revitalize the mining sector. As an example, Market Vectors Coal (KOL), the exchange-traded fund for coal, was trading at over $60 in June 2008. Now Market Vector Coal is around $20. It is the same story for copper, with the exchange traded fund, iPath Dow Jones USB Copper (JJC), now around $40 a share: in 2008, it was close to $60.

Global urbanization should contribute a great deal to the recovery of Caterpillar's stock price.

In an interview in Barron's, Carl Weinberg, chief economist of High Frequency Economics, was very bullish on economic growth in China, which also happens to be Caterpillar's biggest customer. China also consumes more coal, copper and iron ore than any other country, and is vital to the health of the mining industry.

Weinberg was positive on a China boom, noting it "grows by moving people from the farms to the cities, and every time someone moves off the farm into the city, they contribute six times more to GDP than they did on the farm. If you do this 10 or 20 million times per year, you get 6 percent to 8 percent GDP growth just out of the demographics. So that's my outlook for China."

This is a trend that is happening around the world.

According to a study by Mckinsey & Co., the global consulting firm, expanding cities could "inject up $30 trillion a year into the world economy by 2025." That growth will require tremendous amounts of coal, copper, and iron ore. It will also place more of a requirement for machinery in the agrarian sector, where Caterpillar is also strong.

The strength of Caterpillar's appeal now is how undervalued it is by several measures.

The price-to-earnings growth ratio for Caterpillar, one of the most important indicators according to investing legend Peter Lynch, is just 0.67. For Lynch, a PEG of one is adequate for a company: the lower, the better. Based on its PEG, Caterpillar is selling at a one-third discount. That bargain level is reflected in the price-to-sales ratio, too. At 0.91, Caterpillar is selling at almost a 10 percent discount for the value of its sales, as accounted for in the stock price.

For growth investors, analyst projections are alluring.

The earnings-per-share growth for the last five years for Caterpillar was 9.6 percent. For the next five years, the analyst community expects it to be 20 percent. A doubling of the growth rate for earnings per share is bullish, indeed. The current cost-cutting regime instituted at Caterpillar will do much to increase earnings in the future, too.

The falling share price makes Caterpillar even more attractive for income investors.

Due to the drop this week, the dividend yield for Caterpillar is almost 3 percent. The average dividend for a member of the Standard & Poor's 500 Index is around 1.9 percent. With a payout ratio of 24 percent, The Cat has plenty of cash to increase the dividend or initiate a stock buyback program to reward shareholders.

Caterpillar traded around $83.38 Tuesday. That's close to its 52-week low.

There have been a series of downgrades, but Barclay's just reiterated its recommendation for Caterpillar with a target price of $95 a share. For growth, value and income investors looking to profit for the long term from the forces of global urbanization, Caterpillar is attractive, especially when the stock price declines.

Read more from Benzinga

Oct 29, 2013 1:49PM
$95 / share....possibly, and probably not until commodities pricing return somewhere close to previously seen levels.......and, correspondingly, the miners of these substances start investing in capital equipment again...the trend for almost all underlying fundamentals remains negative

Going long with this solid, well managed organization makes sense when the shares hit bottom.  At this juncture, the company, dealers and customers are wrestling with circumstances largely beyond their control and no one can predict where or when we will see an inflection point in the fundamentals that historically make this Cat purr.  Be patient folks and buy low!

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