Caterpillar is probably close to its revenue peak
The definition of a cyclical business could just as easily be one that sells construction equipment, mining equipment, and gas turbines. Trying to figure out when to invest in these highly cyclical companies is almost more art than science.
The global leader in this field is Caterpillar Inc. (NYSE: CAT), with operations in more than 50 countries around the world. The name was derived in 1904 when Benjamin Holt replaced the rear wheels of a Holt steam tractor with a pair of tracks to help farmers deal with soft soils. During a field test in 1905, the company photographer exclaimed that the machine crawled like a big caterpillar.
Caterpillar is expected to generate more than $58 billion in revenue in 2022 and currently has a market capitalization of approximately $119 billion. It’s still doing well at the moment, but as a recession begins to unfold and construction begins to crumble, Caterpillar shareholders could be in trouble as their shares are currently trading at record highs.
About the company
Caterpillar operates through four segments: construction, resources, energy and transportation, and financial products. The Construction segment manufactures a wide variety of construction equipment, such as asphalt pavers, excavators, cold planers, etc. mining and heavy construction. The Energy and Transportation segment manufactures motors and integrated systems for power generation purposes in a wide variety of industries and applications. Finally, the Company’s Financial Products segment provides financial support for customers to purchase its products through finance and finance leases, installment sales agreements, working capital and wholesale financing, as well as insurance and risk management products.
The company recently released its third quarter 2022 results, and it looks like the company is firing on all cylinders. The construction segment saw sales increase by 19% and operating profits by 40%, the resources segment increased revenues by 30% with segment profits up 81% and the Energy and Transportation increased revenues by 22% and operating profits by 32%. The familiar theme of these large increases was favorable price realization, meaning the company raises prices for all of its customers, which is also a familiar theme in most industries today.
The operating margin was 16.2% for the quarter, compared to 13.4% for the same period of the previous year. Adjusted earnings per share were $3.95, compared to adjusted earnings per share of $2.66 in the third quarter of 2021.
President and CEO Jim Umpleby said, “Our team remains focused on serving our customers as we continued to see healthy demand in most of our end markets during the third quarter.
The company has a complicated balance sheet because it finances a large part of its equipment sales. The company has funding liabilities of $22.7 billion, making it a pretty decent sized bank. This item is offset by financing receivables of $20.7 billion. Traditional debt stands at $13.7 billion versus cash of $6.3 billion.
During good times, the company generates strong free cash flow, and for the first nine months of 2022 operating cash flow was $5.0 billion and capital expenditures were $868 million. The company repurchased shares during this period for a total of $3.3 billion. Still, investors should question this buyback strategy, as the stock has traded near all-time highs for much of the year.
Caterpillar’s 30-year earnings history is choppy as it often battles recessions. In 2009, revenue fell 37% and earnings per share fell 75% from the previous year.
Still, consensus earnings per share estimates are $13.89 for this year and $15.00 for next year, which seems odd to me with a strong chance of a recession occurring in 2023. That puts the company at 16 times forward earnings this year and 15 times 2023 earnings.
GuruFocus’ discounted cash flow (DCF) calculator gives us a value estimate of $175, 31% below current prices, using next year’s earnings per share estimate of 15, $00 and a long-term global GDP growth rate of 4.0% short for long-term business growth, as Caterpillar is too cyclical to accurately assess it in the short term. During major recessions, companies in this sector can experience significant declines in earnings and stock price.
The company pays an annualized dividend of $4.80, which equates to 2.08% dividend yield. The payout ratio is less than 50% based on current earnings per share estimates for this year and next.
Gurus who recently bought Caterpillar stocks include Murray Stahl (Professions, Wallet) and Mayors and power (Professions, Wallet). Gurus who have reduced or sold their positions include Mario Gabelli (Trades, Portfolio) and Diamond Hill Capital (Trades, Portfolio).
Caterpillar is highly dependent on macroeconomic issues and commodity prices such as steel and oil. With an inverted yield curve and massive layoffs at major corporations, the odds of a recession next year are quite high. With its shares trading near all-time highs, now is probably not the right time to invest in Caterpillar stocks in my opinion. Typically, the best time to invest in cyclical stocks like this has been in the middle of a recession after revenues and earnings have fallen dramatically, causing the stock price to fall, and weren’t. still there.
This article first appeared on GuruFocus.