Is Caterpillar Stock a Buy?

The stock market and Caterpillar Inc.  management appear to be taking a different tone with regard to the construction machinery giant's outlook for 2017. The stock is up nearly 60% since the start of 2016 and now trades at a forward P/E ratio of 30. Clearly, the market is expecting a strong recovery in the coming years, but management's recent commentary has been somewhat more cautionary. What's going on, and who is right?

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Caterpillar vs. United Technologies

It's always interesting to compare stocks like Caterpillar Inc.  and United Technologies Corporation. They both have exposure to the global economic cycle, and in particular construction markets, but their other specific end markets differ so much as to make them significantly different investment propositions. Moreover, Caterpillar's upside prospects come from cyclical strength in areas like mining, energy, and transportation, while United Technologies' largely come from management's successful execution of its plans to transition the company toward long-term growth.

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Caterpillar or United Technologies

United Technologies Corporation and Caterpillar Inc. are both world-renowned U.S. industrial companies with significant exposure to the construction industry. And it's right about there that the comparisons stop. Although President-elect Donald Trump's victory saw both companies' stock price jump on enthusiasm of favorable industrial conditions to come, the key drivers of the stock price of each company are significantly different. Here's a look at what investors need to know before buying either stock.

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Caterpillar Inc or Illinois Tool Works

Illinois Tool Works versus Caterpillar ? At first glance, they appear strange bedfellows, but looking closely at their prospects reveals a lot about the current state of the industrial economy. The former is an all-purpose industrial with exposure to many parts of the economy, while the latter has heavy exposure to oil and gas, mining, and construction. They offer different things to different investors, but overall, which is the better value?

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Why Caterpillar Stock Can Rise Further

Almost every oil related stock got beaten up in 2015, but as you can see below, Caterpillar, Inc (NYSE:CAT) has bounced back strongly in recent weeks. Moreover, other industrial stocks with heavy energy exposure, such as Dover Corporation (NYSE:DOV) and Emerson Electric (NYSE:EMR), have followed suit. Can the rally continue? Let's take a look at three reasons why it can.

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Joy Global Reports Earnings, Caterpillar Investors Take Note

When a competitor's stock jumps 40% in a week, it's usually time to start looking at what's going on. Caterpillar's (NYSE:CAT) end markets include mining machinery, and Joy Global's (NYSE:JOY) recent surge must have had investors thinking Caterpillar could follow suit in due course. So let's take a look Joy Global's results and what they mean to the investment thesis for Caterpillar stock.

JOY data by YCharts.

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When Will Caterpillar Stock Recover?

The eternal question with a company like Caterpillar  is when the cycle will turn in its end markets. As ever with highly cyclical stocks, when the market turns down, its sales fall dramatically, only to rise in similar fashion when conditions improve. In this context, let's look at the underlying sales trends with Caterpillar and what it means for its prospects in 2016.

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Caterpillar (CAT) or Deere & Company (DE) for 2015?

Ask any investor or hedge-fund manager what his favorite stock pairs are and Caterpillar (NYSE:CAT) and Deere & Company (NYSE:DE) are likely to feature near the top of the list. The two are oft discussed in the same breath as their investment propositions are believed to have had much in common during the last decade. However, on closer inspection the two stocks actually have notably different drivers. Let's take a look at them and, in doing so, assess what will guide their stock performance in 2015.

CAT data by YCharts

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Where Does Caterpillar Inc (CAT) go in 2015?

What do you do with a highly cyclical stock like Caterpillar Inc (NYSE:CAT)? It's one thing to try to use common valuation techniques to help make an investment decision, but the truth is that its revenue and earnings numbers are largely guided by movements in its end markets. Moreover, with cyclical stocks it's often the case that they look their most expensive precisely when you should be buying them. In other words, just before their earnings are about to turn up with the cycle. With that said, what's an investor to make of Caterpillar in 2015?


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Aloca Earnings Analysis

Alcoa's  earnings are always interesting because the company gives great guidance on the industrial economy. In addition, the earnings come at the start of the new earnings seasons, and they give Fools the chance to confirm whether Alcoa's commentary matches what their companies have been saying recently. In this regard, shareholders in Cummins, Johnson Controls, and Caterpillar  should follow closely, Alcoa's management had a lot of interesting things to say.



Alcoa upgrades market forecasts, good for Cummins
A summation of Alcoa's end market guidance reveals that the only formal upgrade to its outlook was in the heavy truck and trailer market. The parts in green are where upgrades took place.

Source: Alcoa presentations

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What Caterpillar's Sales Figures Tell You About the Economy

In case anyone was in any doubt as to the ongoing bifurcation in prospects between developed and emerging markets, then Caterpillar's  latest monthly sales data will make it clear. Moreover, based on Caterpillar's numbers, investors in the industrial sector should look closely at their stocks' exposure to various industries. As a consequence of what Caterpillar just reported, companies like Joy Global  can expect some varied conditions in the mining sector, and there was even some negative news for General Electric Company  in the power generation market. It's time to look more closely.



Caterpillar reports mixed construction trends
The company reports out of three separate industrial segments, and Fools already know that in its first-quarter results in April, Caterpillar upgraded its forecast for full-year construction machinery sales from 5% to 10%. At the same time, it downgraded its view on full-year resource industry sales from a negative to 10% to a negative 20%. Its energy and transportation guidance was left unchanged. Fast forward to the May sales data and a few themes are emerging.

First, there appears to be a strong divergence between Asia/Pacific and North America in terms of construction trends.

Source: Caterpillar presentations

In addition, according to a Bloomberg research report, China's fixed-asset investment continues to moderate from the torrid pace of growth in previous years.


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Stocks to Win the War on Coal

In another blow to the coal industry, the Environmental Protection Agency, recently announced rules demanding that power plants should reduce carbon emissions by 30% from 2005 levels by 2030. The likely effect of enacting these rules will be to damage prospects for U.S. coal miners, and with China increasingly concerned with reducing its dependence on coal, their (coal miners') export prospects could also be adversely affected in the future. With that said, it's time to look at which companies have upside and downside opportunities if the "war on coal" continues.



False dawn for coal mining?
You don't need to be Einstein to understand the importance of relativity, and the fact that Joy Global's    management recently predicted U.S. coal production would be incrementally positive this year is obviously a short-term positive.

However, it's far too early to conclude that coal has passed an inflexion point on the way to another multi-year expansion. For example, Caterpillar   recently lowered its forecast for full-year resource industry sales from a negative 10% to a negative 20%. Caterpillar's stock price is doing well this year, but it's more about the construction sector exceeding expectations and successful implementation of manufacturing cost reductions.



In addition, A quick look at U.S. coal production over the last 30 years demonstrates the demise of coal in recent years. Moreover, Fools should note that the extent of the period of decline since the last recession indicates that this isn't just an adjustment to a slowdown in global growth.

US Coal Production data by YCharts.

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Caterpillar, Johnson Controls and NCI Building Systems: Set for a Better Second Half?

Anyone wondering about the state of play in the economy should keep a close eye on the commercial construction sector in the U.S. While, the recovery in the U.S. residential market is likely to moderate from its torrid pace last year, the commercial construction sector has yet to really take off at all. In this regard, Caterpillar , Johnson Controls and NCI Building Systems  are all interesting to look at for clues as to if and when the sector will meaningfully contribute to economic growth again.

Caterpillar and Johnson Controls
At first, they may appear to be a disparate collection of business to look at, but all three have a specific exposures to the industry. Moreover, as outlined in a previous article they all looked like they were giving somewhat conservative guidance in their results in the first calendar quarter. Now that the second calendar quarter results are in, what are they saying about the state of the industry?

Caterpillar's results and guidance were the most positive overall, as the company upgraded its full-year forecast for construction machinery sales from 5% to 10%. Essentially, Caterpillar's construction machinery sales are receiving a boost from an inventory rebuild by its customers after they ran down inventory in 2013. On a positive note, management also outlined on the conference call, that there had been an increase in end-user demand -- a good sign for the industry.

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Why Deere is a Better Value Than Caterpillar

Investors often obsess over the short-term profitability of an equity, rather than considering the bigger picture of how the stock will work in their portfolios over the longvterm. Such thoughts spring to mind when I consider buying Deere & Company instead of a peer like Caterpillar . In short, Deere is facing a number of short-term negatives, but there is a growing case for buying the stock as a long-term hold.

Caterpillar and Deere, a tale of two markets
Any analysis of these two stocks will show that they tend to be highly correlated, but that doesn't mean they will be so in the future. Simply put, Caterpillar is much more of a play on construction and resources, with the two segments combining to generate 58% of product revenue in its first quarter. Meanwhile, Deere is more focused on agriculture and turf, which made up 83% of its machinery sales in its recent second quarter.

While, construction, mining and agriculture tend to be cyclical industries, there is no specific reason why they must all operate within the same cycle. However, investors don't always see it that way. Indeed, Deere and Caterpillar are often seen as de-facto plays on global growth, and in particular in China.

The idea being that the growing middle class in emerging markets will create more food demand, particularly for protein, which in turn demands more feed production. Meanwhile, the same growing middle class will demand more construction activity and therefore mining materials.

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Time to Buy Caterpillar and Joy Global?

The relative outperformance of Caterpillar  and Joy Global  in 2014 could easily lead Fools to conclude that the mining sector is making a comeback after a couple of years in the doldrums. Is this the case, or are their stock-specific reasons why these two companies have outperformed?

Caterpillar and Joy Global outperform
Going into 2014, the financial markets were fretting about the potential for emerging market weakness. Not only had a slew of companies reported growth that was less than expected in the BRICs, but fears over the shadow banking system in China, and subsequent defaults, have been at the forefront of concerns. It's usually true to say that if emerging markets catch a cold, then mining and commodities will start sneezing. Moreover, China's torrid pace of capital investment was bound to slow at some time, taking demand for certain hard commodities down with it.

These fears get expressed in the stock prices of mining capital-machinery companies, like Caterpillar and Joy Global. If conditions turn out to be not as bad as expected, then the stocks can see some upside, thanks to value hunters and "relief-rally" buyers coming in.

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NCI Building Systems Equity Research

A lot of hopes are being pinned on the non-residential construction market in 2014, and major companies such as Johnson Controls, and Caterpillar Inc. are hoping for broad-based strength in the sector. In this regard, it's fascinating to look at a company like NCI Building Systems   and see what its outlook means for the sector.

Why NCI Building Systems matters
It's interesting to contrast Johnson Controls and Caterpillar, because the former gave a cautious outlook for its heating, ventilation and air conditioning, or HVAC, markets in 2014, while the latter predicted its construction machinery sales would rise 5%. Johnson Controls may be conservative with its guidance, because current conditions are affected by the weather, and because HVAC solutions are relatively late stage in a construction project.In other words demand tends to kick in later in the cycle. However, Caterpillar's construction machinery is likely to have a longer-cycle demand and be utilized more in early stage work (excavation, earth moving, and the like). Perhaps this explains the difference in outlook?

 

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Joy Global Earnings Analysis

Mining equipment company Joy Global (NYSE: JOY  ) gave results recently, but the real news wasn't so much about what the company said, it was about what the company didn't say. The earnings report was positively received by the market, and investors in competitors like Caterpillar (NYSE: CAT  ) took heart from some of Joy Global's commentary. On the other hand, most of the good news was stock specific, and the underlying end-demand drivers for mining machinery still look weak in 2014. So what exactly can Fools learn from the results?

What Joy Global said in its first-quarter results
The company raised the mid-point of guidance by issuing adjusted diluted EPS guidance of $3.10-$3.50 versus previous guidance of $3.00-$3.50. The bottom end of earnings guidance was raised, and management expects that margins will further improve in 2014.

 

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What you Need to Know About Deere

The agricultural sector hasn't said many positive things in recent weeks. Not only are investors fretting over deteriorating conditions at agricultural machinery distributor Titan, but Deere also recently outlined its expectations for a 3% decline in sales in 2014. Moreover, CNH Industrial  gave news of its expectation of a decline in demand for its agricultural machinery in 2014. In fact, the only good news -- more relevant to a company like Caterpillar within the sector -- is that the construction machinery outlook is improving. So, where does all this leave Deere as an investment proposition? It's time to look at three key factors affecting the stock.

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Caterpillar and Joy Global, Set for a Better Year?

It would be an understatement to say that mining had a difficult year in 2013, and it was even worse for the mining equipment suppliers like Joy Global (NYSE: JOY  ) and Caterpillar (NYSE: CAT  ) . However, investing is about what happens next, and the case for buying into the sector is based on the hope that mining companies' capital expenditure plans will improve in 2014. So, what do Foolish investors need to know before warming to the idea?

Mining capital equipment sales
The market took heart from Caterpillar's recent results, and this should be taken as a marker that the sector can go higher given any signs of a bottoming out in spending plans in the mining sector's spending plans.

 

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