Financial Pros Love This Construction Giant

When you picture a bulldozer, chances are an image of a Caterpillar (CAT) black and yellow giant machine comes to mind.

What stared as tractors in 1925 now encompasses construction and mining equipment, engines, and more that span the globe.

And lately, it’s been top of mind for financial pros who finally put it ahead of Deere & Company (DE) for the first time this year.

For reference, we gave Deere a 9/10 in our April review.

With construction demand heavy even in the face of a recession, Caterpillar faces a growing backlog in both dealer inventories and total orders.

Yet, shares are off their highs by nearly 20%. Does that make them a buy or a warning of things to come?

Caterpillar’s Business

Based out of Peoria, Illinois, Caterpillar is the largest manufacturer of construction equipment in the world.

Its business is split into three industries:

• Construction (39% of sales)
• Resources (20% of sales)
• Energy & Transportation (36% of sales)
• Financial products (5% of sales)

Source: Caterpillar Q1 2023 Statistics PDF

In the latest quarter, results were mixed by region, though heavy investments in North America drove more than offset declines in Asia and Latin America.

That could change soon as China’s economy appears to be heating up.

Overall sales volumes have increased as the pandemic shutdown led to a massive economic order backlog.

Countries around the world are still scrambling to make up for lost time. In the U.S. and North America, a focus on nearshoring and bringing manufacturing home has increased demand for construction equipment. But that’s not to be outdone by the huge push for more domestic energy and mineral production.

Financials

Source: Stock Analysis

Caterpillar is also benefiting from price increases which added $1.894 billion to its Q1 bottom line in 2023 compared to the prior year.

That helped bring operating margins back in line with prepandemic levels.

Free cash flow has also improved by several points, allowing the company to bring down its net debt from $31.5 billion in Q4 of 2022 to $30.8 billion in Q1 of 2023.

Interestingly, Caterpillar only pays around $463 million in interest each year., which equates to a roughly 1.25% interest rate on its total outstanding debt. So long as it pays off debt as it comes due, we don’t expect the interest expenses to markedly increase.

Valuation

Source: Seeking Alpha

Caterpillar is a bit more expensive on an earnings basis when compared to Deere or Cummins (CMI), Pacar (CAR), or Terex (TEX).

However, it’s towards the cheaper end on a price-to-cash flow basis.

On most other metrics, from price-to-sales to EV/EBTIDA, Caterpillar trades at a premium.

Growth

Source: Seeking Alpha

Normally, we’d expect higher revenue growth both trailing and forward to justify loftier valuations.

That isn’t the case with Caterpillar. It’s only expected to grow revenues at 8.7% next year, below all its peers. And its 5-year CAGR is a measly 6.6^.

In fact, if we looked at just the growth statistics, Caterpillar shouldn’t be trading at a premium at all.

Profitability

Source: Seeking Alpha

So, does its margins justify the premium?

Caterpillar doesn’t boast the highest gross margin, though it’s close. And its net income margin is still a few points below Deere’s.

In fact, looking at a return on equity, assets, and total capital, Caterpillar is pretty much in line with Deere.

Our Opinion 6/10

It’s tough to get behind Caterpillar when Deere is simply more attractive, as are some of the peers like Terex.

Plus, the recent stock momentum doesn’t favor the bulls, with shares moving down while the broader market continues to climb.

Caterpillar becomes attractive, down near $150-$180 per share. Until then, it’s simply too expensive for our tastes.