Caterpillar Inc. (CAT), Cummins Inc. (CMI): Three Investing Themes in the Machinery Sector

After the end of earnings season for the first quarter, the market has been looking for investing themes in the machinery sector. In this context, the Street is bullish on companies with high exposure in end markets involving energy, construction and/or trucks. Let’s have a look at some of them and judge whether these companies deserve a buy rating.

Caterpillar Inc. (NYSE:CAT)

A mixed outlook on this company

Order activity in Caterpillar Inc. (NYSE:CAT)’s resource industries segment remains sluggish and has probably not accelerated according to the company’s prior expectations. This could pressure prior full-year guidance for sales of $60 billion to $68 billion and EPS of $7.00 to $9.00. Given that near-term headwinds in the resource industries division could be greater than what the company previously expected, Caterpillar Inc. (NYSE:CAT) lowered its full-year EPS guidance to reflect a midpoint closer to the current 2013 EPS consensus estimate of $7.25.

Beyond Caterpillar Inc. (NYSE:CAT)’s resource industries segment, trends in its other businesses could be relatively more stable. In particular, the construction industries segment may have some remaining inventory correction in the near term (although the majority of inventory issues in construction were taken care of in 2012) and faces difficult year-ago comparisons from a very strong 2Q 2012, but global construction end markets seem poised to continue a gradual recovery.

North American construction markets remain positioned to continue to recover from recession-era lows and the market has been encouraged by some positive signs in Brazilian construction markets. In addition, Chinese construction-equipment demand, while mixed early in 2013, seems to be in a bottoming phase (Caterpillar Inc. (NYSE:CAT)’s March excavator sales in China were in fact up after an extended period of declines.)

Finally, Caterpillar Inc. (NYSE:CAT)’s power systems businesses could hold up relatively well in 2013, supported by still solid demand for the company’s solar turbines, cost reductions in its locomotive business and at least a stable U.S. power-generation market.

Why this company reiterated its 2013 guidance

The expectations for Cummins Inc. (NYSE:CMI)’ 2013 earnings are relatively muted, reflecting well known lingering headwinds in many of the company’s end markets and strong year-ago results. It is interesting to note that, while Cummins Inc. (NYSE:CMI) has guided to full-year 2013 revenue of flat to down 5%, management has also said that 2013 first-half revenue could be down as much as 10%

Cummins Inc. (NYSE:CMI) remained fairly cautious in its outlook for significant near-term improvements in its businesses. However, a bright spot was that the company discussed a bottoming process in key end markets such as China construction and power gen (though not yet with visibility to meaningful improvement in the near term.)