CAT: Why You Need to Own Caterpillar Shares
Avondale Partners initiated coverage at Market Outperform.
TUESDAY, MARCH 23, 2010
WE ARE INITIATING COVERAGE on Caterpillar (ticker: CAT) with a Market Outperform rating and a 12-month price target of $70 (18% upside and 21% total return) with potential to $85 over the next two years as shares discount midcycle valuation on our 2012 earnings per share (about 50% total return).
We view Caterpillar as "need to own" among higher-beta [higher risk], large-cap U.S. industrials given its strong commodity leverage, emerging-markets exposure, and operating leverage. Though we see near-term potential for shares to remain range-bound by macro uncertainty, we expect Caterpillar to outperform on improved confidence over the global economic recovery (particularly sustainability of emerging-market growth) and visibility on bottom-line benefits of self-help initiatives.
While our 2010/2011E [estimated] EPS are about 5% below consensus [estimate], we note: (1) our 2010 EPS equal in line with guidance; (2) 2010/2011 estimated earnings before interest, taxes, depreciation and amortization (Ebitda) is in line with consensus; (3) 2012 estimated EPS -- what we think matters most -- is up 7%; and (4) we believe buy-side expectations are closer to ours.
Caterpillar is highly leveraged to global commodity demand growth with an estimated 40% of 2009 equipment revenues and 60%-plus of profits derived from energy, base metal, and other commodities central to the urbanization, industrialization and modernization of emerging markets (and growth of developed markets). We hold a bullish outlook for these commodities based on futures pricing, consensus economic forecasts, and our bottoms-up producer capital-spending analysis for key end markets.
Caterpillar's rising exposure to faster-growing regions should remain a key driver of strong longer-term growth. In the last 10 years, Asia/Pacific has grown from 10% of equipment revenue to 23% (14.2% compounded annualized growth rate (CAGR) versus 3.1%, excluding Asia/Pacific) while emerging markets -- China, Commonwealth of Independent States [former Soviet states], India/Asean [Southeast Asian Nations] -- grew from 8% in 2005 to 15% in 2008 (37% CAGR versus 10%, excluding emerging markets) with China and CIS growing at 53%/56%, respectively. We estimate emerging-markets exposure nearing 20% of 2009 revenue.
Caterpillar has multiple initiatives under way to improve full-cycle profitability/returns by converting cyclical cost reductions to structural savings and raise asset efficiency. While success requires improved volumes, we are optimistic given actions to-date and the track record of Caterpillar's CEO-elect, as reflected in our above historical average incremental margin expectations.
Our estimates imply 2010-2012 EPS growth of 16%/52%/49% versus consensus of 24%/49%/32%, and equate to a three-year CAGR of 38% versus 33% for the peer group and 21% for core U.S. industrials. Over the next two years, our estimates imply average growth of 33% versus 21% for Standard & Poor's 500, with midcycle EPS profitability reached in 2012. We see revision bias skewed to the upside, based primarily on potential for better cost/efficiency performance, volumes and stock buyback.
-- Ted Grace
The companies mentioned in Hot Research are subjects of research reports issued recently by investment firms. Their opinions in no way represent those of Barrons.com or Dow Jones & Company, Inc. Share prices at the time the report was issued and the date of the report are in parentheses.
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