Why is the market letting you buy $103 of Caterpillar revenues for a price of roughly $170 per share of Caterpillar stock (NYSE: CAT) – implying a price-to-sales, P/S, multiple of close to 1.7x – while for Deere & Company (NYSE: DE), you need to shell out closer to 1.9x? Caterpillar’s 1.7x multiple is based on its $58.5 billion in 2019 sales ($103 in sales on a per-share basis) and a stock price of $170. Can Caterpillar’s stock really be cheaper than Deere and deserve a lower price to sales multiple? The contrast isn’t a whole lot better if you use the sales figures from the last four quarters instead of the last fiscal – using numbers for the last four quarters, Caterpillar P/S is about 2x, compared to Deere’s 2.1x.
Here’s what’s going on. The price-to-sales or P/S multiple for a company is higher when the sales growth is higher, and it has a demonstrated ability to translate those sales to profits, with an expectation to do so consistently.
Sure Deere’s revenue growth is slightly higher (3% average annual revenue growth over the last 5 years vs about 1% for Caterpillar). However, Deere’s Net Margins (net profits as a percent of revenue) are lower (8.3% in 2019 vs 11.3% for Caterpillar). Using another measure of return, Deere’s 7% free cash flow margin (net profits adjusted for non-cash expenses as a percentage of revenue), is also lower compared to 12% for Caterpillar.
Our dashboard Caterpillar vs. Deere: Is CAT Stock Appropriately Valued Given It’s Lower P/S Multiple Compared to DE? details the fuller picture based on Revenue Growth, Returns (ability to generate profits from growth), and Risk (sustainability of profits), parts of which are summarized below.
- Revenue Growth
Deere’s growth has been stronger than Caterpillar over the last five years, with Deere’s revenue expanding at an average rate of 3% per year from $28.9 billion in 2015 to $39.3 billion in 2019, versus Caterpillar’s revenue which grew 14% from $47.0 billion to $53.8 billion.
- Deere’s revenue growth was partly led by the Wirtgen acquisition and higher volumes, due to the overall economic growth and robust U.S. housing market over this period. Caterpillar, on the other hand, has seen slower growth due to lower sales volume driven by the impact of changes in dealer inventories and lower end-user demand.
- Now, the low-interest-rate environment following Covid-19 has made investors take a longer-term view, valuing higher growth companies more richly. For perspective, Deere’s market capitalization stands at over $75 billion currently, reflecting a 117% growth since mid-March, compared to about $91 billion for Caterpillar (85% growth since mid-March).
- Returns (Profits)
Coming to Returns, Caterpillar has a clear edge over Deere.
- Deere’s Free Cash Flows as a percentage of revenue stood at about 9% in 2019, below Caterpillar’s 13% over the same period.
- Deere’s Return on Invested Capital (ROIC) is also much lower compared to Caterpillar (11% vs. 73%).
- Looking at Total Shareholder Returns, Deere’s 20.4% fall short of the 22.6% figure for Caterpillar.
Deere looks like the riskier of the two companies from the perspective of financial leverage.
- Cash-to-Assets Ratio: Caterpillar is in a better cash situation compared to Deere (23% vs 11%)
- Debt: CAT has a smaller proportion of debt on its balance sheet compared to DE ($38.6 Bil vs $48.5 Bil).
- That said, both the companies have adequate liquidity to manage their operations and service their debt, with cash position standing at over $8 billion for both the companies in the most recent quarter.
But there’s more to the risk story. Deere’s P/S multiple has swelled from 1.4x at the beginning of the year to its current level of 1.9x. The metric hasn’t seen much growth for Caterpillar, growing from 1.5x to 1.7x.
In summary, though Deere’s sales growth is higher, Caterpillar’s lower price-to-sales multiple compared to Deere looks attractive. CAT stock also appears to be less risky in comparison to DE stock. This is all sensible if you believe in a strong economic recovery post-Covid. The actual recovery and its timing hinge on the broader containment of the coronavirus spread. Our dashboard Trends In U.S. Covid-19 Cases provides an overview of how the pandemic has been spreading in the U.S. and contrasts with trends in Brazil and Russia.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.