Inside Wall Street: CAT investors should get a grip

Despite worries about China, continued growth prospects for the global construction machinery maker are on target.

By Gene Marcial Mar 26, 2012 9:59AM

Caterpillar (CAT) shares climbed to a 52-week high of $116.95 on Feb. 24. The move caused jitters among most investors rather than instilling confidence in the world's largest producer of earth-moving equipment. But some close Caterpillar watchers and big investors see little reason for investors to panic.


Of late, any headlines that may affect CAT's operations create nervousness, even among some bulls. And when the disturbing news involves China's vast market, many shareholders feel unhinged. The concern is further exacerbated by some analysts and bears who can't wait to see the stock push back.


In recent days, shares of Caterpillar did slide as a result of worries that China's economic growth is slowing and that its demand for iron ore will shrink as a result.


But according to the bulls, there's one important point to factor in: Long-term growth potential remains robust.


The bulls point to the continued increase in average worldwide machine and engine dealer sales. There is huge demand potential arising from the need to replace old machinery and power systems in developed nations, as well as the robust construction growth in the developing and emerging markets in Asia and the Pacific. That's not all. The bulls expect upward changes to the company's earnings estimates, with continued growth over the long haul.


The bulls don't ignore the negative headlines about China, and they expect they could bring more downward pressure on Caterpillar's shares. But they would rather focus on the growth potential of markets in Eastern Europe, the Middle East and Africa.


"Caterpillar is in the midst of a robust business recovery, and we see growth going on for an extended period," says Michael Jaffe, an analyst at S&P Capital IQ. He says the stock is undervalued and recommends the stock as a buy, with a 12-month price target of $145 a share.


The analyst notes that Caterpillar's distinctive yellow machines are in service in nearly every country in the world, with 65% of sales outside of North America, as of 2011.


Jaffe also says he has a "very positive view" of Caterpillar's $8.8 billion purchase in July 2011 of Bucyrus International, "which expanded CAT's footprint in what we view as a robust market." Bucyrus manufactures mining equipment for the surface and underground industries, whose revenues totaled $3.7 billion in 2010. Caterpillar expects Bucyrus to bring more than $500 million worth of annual synergies by 2015.


The analyst forecasts revenue to jump 19% in 2012, following a 41% growth in 2011, when sales totaled $60.13 billion, up from 2010's $42.58 billion. Earnings in 2012 are expected to soar, to $9.65 a share from 2011's $7.40 per share and 2010's $4.15 per share.


The stock is way undervalued, Jaffe says, trading at just 11.5 times his 2012 profit estimate, which is at the low end of Caterpillar's typical valuation price-to-earnings ratio range. His price target of $145 a share reflects a price-to-earnings ratio of 15. The stock's price-to-earnings was as high as 43 in 2009. Last year, the price-to-earnings multiple was 16.


Another analyst, Lawrence de Maria of investment bank William Blair, says, "We remain bullish on full-year 2012 prospects and believe earnings revisions will be positive, with continued long cycle growth."


He notes that Caterpillar's CEO has continued to reiterate his bullish outlook, and management hasn't changed its tone in expecting ample demand for the company's products. Apart from tractors and earth-moving equipment, Caterpillar also makes electric power generators and engines used in petroleum markets, as well as mining equipment.


De Maria, who rates the stock as "outperform" with a 12-month target of $135 a share, says the company continues to view the China market from a multi-decade time horizon, and that the company is positioning itself to capitalize on the strong secular growth opportunity in that country.


Analyst Theoni Pilarinos of investment bank Raymond James, who also rates Caterpillar as "outperform," says that despite concerns about the Chinese economy, "CAT is still well poised for growth given its key construction markets in the U.S. and Europe, which are still below their peak levels; a record order backlog of $30 billion; and management's solid execution and operational performance." He forecasts earnings of $9.35 a share for 2012, and $11 per share for 2013.


"We encourage long-term investors to hold on to their CAT shares," Pilarinos says.



Gene Marcial wrote the column "Inside Wall Street" for Business Week for 28 years and now writes for MSN Money's Top Stocks. He also wrote the book "Seven Commandments of Stock Investing," published by FT Press.



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