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Caterpillar: We’re Trading At 6x 2015 Earnings, Not 5x

The financial markets have been thrown into a tizzy after Caterpillar Inc. (NYSE:CAT) revised its earnings forecast for 2015 to center on $15 in EPS rather than its previous forecast centering on $17.50. The stock is down in pre-market trading to about $89, which represents a 6x multiple on the new earnings forecast (as opposed to just above 5x the previous forecast). At the low end of the internal earnings projections- the range of potential figures is between $12 and $18- the stock trades at 7x the company’s estimates.

The company is currently trading at 9x consensus forward earnings estimates in an environment where investors are worried about Chinese and global macro conditions (Caterpillar Inc. is closely tied to the global economy, and its beta is 1.8). Let’s consider where its stock price would be if it is still trading at 9x forward earnings two years from today. At the midpoint of Caterpillar’s new forecast- $15 per share- it would trade at around $135. At the low point, $12, it would trade at $108 which would still be a 21% gain compared to a price of $89. That comes out to a 10% annualized gain. Similar math gives a 23% annualized return assuming the midpoint of Caterpillar’s forecast turns out to be true, and in either case capital gains would be supplemented by the company’s dividend yield (currently at 2.3%).


As a result, we don’t see the updated guidance as particularly bearish for the stock. There are of course many factors which could affect Caterpillar’s forward multiple down the line, either in a positive or negative direction, and the company’s earnings could end up even lower if macro conditions particularly disappoint. But if an investor is going to believe Caterpillar’s management (and if not, why pay attention to this news?) the stock is more of a buy than a sell at current prices. The sell-side is bullish as well. We’ve discussed the forward multiple derived from their earnings estimates for 2013; their longer-term forecasts give a 5-year PEG ratio of 0.5. And despite concerns about macro weakness, Caterpillar’s earnings last quarter came in 67% higher than in the same quarter a year ago.

Billionaire Ken Fisher’s Fisher Asset Management trimmed its stake in Caterpillar by 3% but still owned 3.9 million shares at the end of June (find more stocks owned by Fisher Asset Management). Renaissance Technologies, founded by billionaire Jim Simons, added shares to a total of 2.6 million during the second quarter (see more stock picks from Renaissance Technologies). Steve Cohen’s SAC Capital Advisors also increased its position during the quarter.

CNH Global NV (NYSE:CNH) sells construction and agricultural equipment, and is even more tightly tied to the broader market at a beta of 2.6 than Caterpillar Inc. CNH is also cheap at 9 times forward earnings estimates but is a considerably smaller company ($9 billion market cap versus $58 billion) and while it grew its earnings last quarter compared to a year ago it did so at a lower rate. Joy Global Inc. (NYSE:JOY) is focused on providing mining machinery and equipment. It is very similar to CNH: it carries a higher beta at 2.3, it is a smaller company at a $6 billion market cap, it grew its earnings at about the same rate last quarter over the last year, and it too trades at a forward P/E multiple of 9. We think that Caterpillar is the best buy between these three companies.

Two other large players whose fortunes are closely tied to the state of the global economy are Freeport-McMoRan Copper & Gold Inc. (NYSE:FCX) and Vale SA (NYSE:VALE); these miners’ capital expenditures also help determine the demand for Caterpillar’s equipment. Both of these companies saw their earnings come in lower last quarter than in the same period in 2011 (which is part of the reason why they may cut their spending). Their earnings multiples are also in about the same ballpark as Caterpillar: Freeport McMoRan trades at trailing and forward multiples of 12 and 8, respectively, while Vale’s are in the 6x-7x range.

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