CAT-astrophic? Not In Our View
When we wrote about CAT in June of this year, we were clear that we were making a bottom of the cycle valuation call, and we also highlighted the risk that negative revisions might not be over. To be fair, today’s revision was somewhat larger than we would have guessed, but that does not leave us feeling any different about the story.
CAT remains a very strong player in markets that are experiencing a cyclical bottom (most notably mining); it has controlled costs and cash flows much better than in prior cycles and has tremendous leverage to any general economic recovery and mining rebound.
The guidance for 2014 is in our view very conservative, but appropriately so, given how badly the company estimated demand in the mining sector this year. Moreover, the CEO would not be drawn on the timing of any mining recovery during a CNBC interview this morning – once bitten…..
With the new forward guidance of $5.50 per share the stock is trading at 15.25x forward earnings this morning. If this is the “trough” for CAT this is a low trough multiple – we have seen 20-25x in the past when the company has been in much worse shape and the S&P much less valuable from a PE perspective – see chart. These peak multiples also exist in troughs prior to 1995, but in those troughs earnings were negative and the chart is very messy.
Barring some sort of global economic meltdown, we do not expect the stock to get much cheaper than it is today on an absolute basis and even with an economic meltdown it will probably do well on a relative basis. On a normalized basis we see the earnings power of the platform closer to the $7.00 per share which was this morning’s consensus estimate for 2014, and in a peak we think that current platform could earn well over $10 per share. In the meantime, the company does not need much capex and is generating plenty of free cash so we see the share buyback continuing.
Separately we looked at valuation relative to net assets – see second chart. While this ratio is not as low as it was prior to 2002 and in the lows of 2008, it is well off its peak and the company would argue that its assets are much more productive than they were 10 years ago. Furthermore, we have a much better balance sheet and much more free cash. The risk would be that the company uses its cash flow and the fear of limited growth to make another large acquisition. As we indicated in June, CAT is so much cheaper than the rest of the sector, and any acquisition would likely be quite dilutive and consequently we think that such a move is unlikely. We expect surplus cash to be returned to shareholders.