Caterpillar Inc. (CAT), the world’s biggest maker of construction and mining equipment, is seeing revenues squeezed as a result of the protracted trade war between the United States and China, as well as slowing global economic development. The company’s shares have also taken a hit, falling almost 19% from their highest closing high in January 2018. They are up over 5% year to far, but behind the larger market by approximately 15%.
Recent encouraging trade news, including as scheduled discussions between the two nations in Washington and China’s tariff exemptions on some US imports, have boosted the stock in recent days. However, if the trade war has taught us anything, it is that good news may swiftly fade. The trade war will not be settled until both nations reach a formal trade agreement. It may be some time before that occurs.
- Trade conflict and slowing global growth Profits are being squeezed.
- The stock is down 19% from its top in January 2018, behind the market.
- Significant weakness in construction and energy and transportation.
- High equipment inventories indicate sluggish demand.
What It Means for Investors
According to Bank of America analyst Ross Gilardi, Caterpillar faces a variety of near-term obstacles. The construction and upstream oil and gas sectors are also struggling. He expects that profits in the company’s construction section will fall by 30% from peak to trough, while earnings in the energy and transportation segments would fall by 15%.
While those decreases should be mitigated somewhat by a 5% increase in Caterpillar’s mining profitability, Gilardi cautioned that the capital expenditures (CapEx) outlook in oil and gas is not promising, and estimates continue to drift downward. He believes the business will suffer one or two more quarters of negative EPS revisions and somewhat lower profits in 2020.
Gilardi is hopeful in the long run. He recommends investors to look past the near-term decline in EPS since global PMIs are starting to bottom out and the US service economy remains strong. He reaffirmed Bank of America’s buy recommendation on Caterpillar, stating that the mining industry’s predicted sustained expansion, as well as increased assistance from global central banks, would help to drive the stock’s price higher.
Not all experts agree with Gilardi’s long-term outlook. Concerned about the US-China trade war and the future for global growth, Stephens analyst Ashish Gupta cited his firm’s underweight recommendation on the company last month. Despite the transition to looser monetary policy, he does not anticipate a torrent of money from central banks to increase economic production overnight.
Slowing Chinese economic development will have a particularly detrimental effect on the whole resource business, which includes some of Caterpillar’s largest clients. The business said in its second quarter financial report, released at the end of July, that a 22% reduction in its Asia-Pacific unit’s construction sales was mostly attributable to sluggish demand in China. Tariffs, according to the corporation, were one of the reasons its production costs were higher.
The construction industry’s sluggishness has already taken a serious toll on demand for Caterpillar’s construction equipment. Gupta cites the company’s current greater equipment stocks as evidence of weak demand. “Excess dealer inventory suggests lower reported sales in the future quarters for Caterpillar,” wrote Gupta in a research note issued last month, according to Barron’s.
To be fair, Gilardi’s argument supporting his long-term optimism is that all of these challenges are already accounted for in Caterpillar’s current stock price. If he is correct, investors might buy the company for a steal at its present price and be handsomely rewarded when the economy improves.
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