It looks as if we've dodged a bullet, and the U.S. economy will
be able to avoid another deep slump. But tepid growth may be the
best we can hope for in the foreseeable future. Yet beyond our
borders, growth should prove more dynamic, especially in emerging
market economies. As China, Vietnam, Indonesia and other neighbors
transform into world-class economies, they'll need to ensure that
their infrastructures can handle a steady wave of growth. And
they're likely to continue consuming large amounts of oil, gas, and
other commodities to build the highways, power plants, and other
hallmarks of a modern economy.
I can think of no clearer way to play that trend than
, the global heavy machinery powerhouse. Caterpillar has steadily
increased its exposure to the Asian economies during the past few
years, and also stands primed to benefit from rebounding demand for
excavation and mining equipment to pull all of the key commodities
out of the ground.
Like many multi-nationals, Caterpillar has surely seen some tough
times. Sales fell a hefty -37% in 2009 to $32.4 billion, the lowest
level since 2004, and per-share profits fell nearly -75% to
$1.43. That's well below the $5 to $6 a share the company
earned in the previous three years. Yet there is a clear silver
lining: management has implemented a wide range of improvements to
the business with an eye toward boosting profit margins. As a
result, profits should be sharply higher in the next peak of the
For starters, the company is sharply reducing the number of parts
used to build its various machines and engines. That has given
Caterpillar pricing leverage with suppliers, as higher volumes of
fewer parts yield price concessions. Moreover, the company has
hired a range of external manufacturing managers from firms such as
and General Motors that bring expertise in terms of material
handling, production de-bottlenecking and quality control. As a
result, the company thinks it will save several hundred million
dollars annually on warranty claims, labor productivity and
These steps are just getting underway, and any benefits are being
masked by a still-weak global economy. Yet signs are emerging that
the U.S. economy is no longer in freefall, and Asian economies are
starting to heat up. Asia, in particular, bears close scrutiny.
Analysts at Smith Barney believe that the Asian region will see
$700 billion in infrastructure spending over each of the next five
years. That's up from $370 billion in each of the last two years.
They and others note that Caterpillar's exposure to China is
In the United States, the upturn will be slower to materialize, and
could take two to three years to reach fruition. For example, the
company's network of dealers reduced inventories in 2009 by nearly
$4 billion, down to bare-bones levels. It's not clear when normal
inventory levels will rebuild, but they should provide a solid
tailwind, exceeding actual end-user demand. In addition, the U.S.
and European construction markets, which have been in a slump for
some time, should start to thaw over the next 12 to 24 months.
Morgan Stanley's analysts note that the dealer networks for rival
equipment manufacturers "struggle to remain viable" after the sharp
sales slowdown, which should lead to rising U.S. market share for
To be sure, Caterpillar's transformation will not happen quickly,
but shares should benefit from a sense that the company will emerge
from the downturn in a very strong position. As cash flow rebuilds,
look for the company to boost its dividend (which currently yields
nearly 3%), buy back stock and pay down debt. As noted, per-share
profits could exceed $8 if sales rebound to 2007 levels, thanks in
large part to the myriad streamlining efforts.
With the exception of some especially bullish and bearish market
phases, shares have traditionally traded for around 15 times
profits. Assuming shares only trade up to around 12 times peak
cycle profits of $8 a share, then the stock could well rise close
to the $100 mark. That's roughly 65% above current levels. It will
take several years for that investment thesis to be realized, but
Caterpillar clearly stands out as a platform for the global
economic rebound - especially in Asia and in commodities.
-- David Sterman
P.S. We've already seen how Caterpillar's shares can zoom with
the right profit catalysts: Soaring commodity prices in 2003 helped
trigger a rush for Caterpillar's products that pushed up its
revenue by +100%, its profit by +220%, and its stock price by over
+200% in the following five years. Go here for a list of our
favorite "profit catalyst" stocks for today's market.
Disclosure: David Sterman does not own shares of any security
mentioned in this article.