CAT – By Some Measures Still a Long Way to Go
Our position on CAT is unchanged from the company specific research we wrote in June of last year, we still have an out of favor stock at the bottom of an earnings cycle – but perhaps on the path to recovery. Valuation has been hurt by the earnings and by grouping the company among the relatively unloved for the last 2 years. CAT has the ability to outperform on two fronts – as earnings grow and as its relative multiple expands. In the first chart we repeat and update a chart that we showed in our piece on CAT from last June. CAT remains at a significant discount to our Capital Goods Index – an Index which includes CAT as a component. There is some slight movement away from the peak that we saw late last year, but there remains a significant distance to return to average levels of the past, or even a more conservative trend.
This chart speaks to CAT’s relative position versus its peer group, but the Capital Goods space in aggregate is cheap relative to the Industrials and Materials sectors as well, suggesting that CAT has upside relative to the group and the group has upside relative to other groups in the same broad space – second chart.
On an absolute basis CAT continues to earn 100 basis points below normal on a return on capital basis, but with this quarter the recent downward trend has become an upward recovering trend – see chart. In our model, mid-cycle earnings are around $6.95 per share and while this may not be achievable in 2014, it looks more than achievable in 2015 in our view, supporting an end 2014 “normal value” close to $120 per share – more than 30% upside from current levels.