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Caterpillar Inc. (CAT): Buy Now or Wait Until Chinese Macro Fears Subside?

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Caterpillar Inc. (NYSE:CAT)Caterpillar Inc. (NYSE:CAT)‘s stock has been a roller coaster ride. It rallied from the low $20’s in the depth of the financial crisis to a high of $116. With China slowing, the stock has since retraced back to the $80’s and is down 7% year to date. Should investors buy now or wait until the Chinese economy recovers?

Fundamentals

Caterpillar Inc. (NYSE:CAT) manufactures and sells construction and mining equipment. It is most famous for the yellow bulldozers and construction equipment that line many construction sites, but with the acquisition of Bucyrus International two years ago, it is also deeply in the mining business.

Valuation-wise, Caterpillar is a fairly priced stock with shares trading at 11 times earnings and 10 times next year earnings. The company pays its investors an above average dividend of almost 3% and has a payout ratio of only 20%. Caterpillar Inc. (NYSE:CAT) has steadily raised the dividend over time, and
even during the financial crisis of 2008.

Analysts are neutral on the stock. UBS has a price target of $84 while RBC Capital Markets has a higher target of $92. Analysts, on average, expect a five-year annual earnings growth rate of 14%.

Macro fears

The big reason for Caterpillar Inc. (NYSE:CAT)’s recent weakness is China. Because Caterpillar makes excavation and mining equipment, it is highly levered to the building boom in China, which consumes over 45% of the world’s steel. Unfortunately, the building boom is slowly losing steam. There are many ghost cities in China, such asOrdos, with many houses but no residents.

Source: GeoEye

The building boom spurred demand for iron ore, coal, and excavation equipment. Caterpillar and its rivals, Joy Global Inc. (NYSE:JOY) and Deere & Company (NYSE:DE), all benefited from it. But now that housing construction is slowing down, there is not as much demand. According to Caterpillar Inc. (NYSE:CAT), industry-wide sales of construction equipment in China are abouthalf the levelof two years ago. As a consequence, despite the hot U.S. housing market, Caterpillar’s gross margin is down from 30% to 26% and profit margins are down from 7% to 6.4%.

Hedge fund manger Jim Chanos, who is short the company, estimates that roughly half of Caterpillar’s profits come from capital expenditures of mining companies. As there is less demand for iron ore, due to the building bust in China, Caterpillar Inc. (NYSE:CAT)‘s profits will take a hit.

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