Caterpillar Inc. (CAT), Cummins Inc. (CMI): Is This Cat About to Pounce Back?

Page 2 of 2

Latin America

This region accounted for only 14% of Caterpillar’s revenue in 2012. So why is this region important? In 2012 the three regions with the highest growth rates in net sales were Asia/Pacific, Latin America and North America (in that order). The economic slowdown in China and the potential decline in revenue in the U.S. suggest Latin America might lead the way in growth in sales.

This region is likely to be the driving force for companies such as Deere. The company projects net revenue in its agriculture and turf, a business segment that accounts for more than 80% of Deere total revenues, will increase by 15%-20% in 2013 mainly due to growth in Brazil’s economy. Therefore, this region’s economic direction will determine the growth (or lack of it) of these heavy machinery manufacturers.

Profitability also falls

Caterpillar’s drop in revenue isn’t the only decline the company experienced; its profit margins also dwindled in recent quarters. In the second quarter, the company’s profitability reached 10.65% compared to 15.06% in the same quarter in 2012.

In comparison, in the recent quarter, Deere’s profit margin reached 16%, which was close to its profitability last year. Cummins Inc. (NYSE:CMI), much like Caterpillar, experienced a drop in profitability; in the first quarter, profit margin slid to 10.6%. If Caterpillar’s profit margin will further dwindle, not only could it adversely affect its stock price, but also its dividend payment.

Valuation

Despite the drop in the share price of Caterpillar, its current enterprise-value-to-EBIT ratio remains the highest of the three companies listed above. I have used this ratio because it takes into account the financial structure of the company including its cash and debt.

Deere’s ratio is close to the machinery market average, and Cummins Inc. (NYSE:CMI)’s ratio is slightly lower than the market average. This means, at face value, that all three companies are roughly priced at the same ballpark and next to the market average.

The table below summarizes the valuation of all three companies based on enterprise-value-to-EBIT ratio.

The Foolish bottom line

Don’t get me wrong, I think Caterpillar is still a great company with solid foundations that could make great strides over time. But the future economic developments in China and the U.S may further pull down its revenues and profit margins. The company’s current valuation is still slightly higher than other leading heavy machinery companies (but not by much), which makes its current valuation less appealing. But if the company’s stock price will continue to fall, it will eventually lead to an opportunity worth considering — an opportunity that will make this company’s stock worth adding to your portfolio.

The article Is This Cat About to Pounce Back? originally appeared on Fool.com and is written by Lior Cohen.

Lior Cohen has no position in any stocks mentioned. The Motley Fool recommends Cummins. The Motley Fool owns shares of Cummins. Lior is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.

Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

Page 2 of 2