China Slowdown A Threat To Caterpillar’s Valuation

-13.48%
Downside
365
Market
315
Trefis
CAT: Caterpillar logo
CAT
Caterpillar

Caterpillar’s (NYSE: CAT) share price has witnessed a sharp decline of over 30% year to date. [1] This can primarily be attributed to low end user demand for construction and mining equipment, which has weighed on the company’s earnings as well.  Asia Pacific revenue from construction and resource segments were down in double digits in the third quarter, primarily reflecting lower than expected sales volume in key markets such as China and Japan. [2] The sharp decline in China sales was the result of the slowdown in the Chinese economy which is not expected to bottom out in the near term. Moreover, the government devalued the Chinese Yuan, adding additional pressure on dollar sales. On that note, we will review the issues the company is facing in key markets and their implications.
CAT Stock price
    See our complete analysis of CAT here

China Slowdown Is Weighing On Caterpillar’s Construction Industries’ Revenues

Caterpillar’s construction industries revenue peaked during the 2010-to-2012 timeframe but hasdeclined subsequently and is expected to hit rock bottom in 2015. This resulted from the slowest recorded growth in China’s economy since 2009 (projected at 7.1% in 2015). [3]  As a result, the construction activity in China in both residential and non-residential segments has slowed down. Caterpillar’s construction equipment sales volumes have sharply declined due to lower new equipment and aftermarket parts deliveries. The Asia Pacific region, where China is a key player, accounts for around 20% of the company’s construction industries revenue. While China sales have trended downwards since 2012, we expect a slight improvement in the coming years. However, a bounce back to 2010-2012 level seems unlikely in the medium term. [4] If revenue falls by 5% over the next two years, Caterpillar’s valuation will come down by another 5% coming fiscal.

Relevant Articles
  1. Does Caterpillar Stock Have More Room To Grow After Its 25% Gain Last Year?
  2. Following A 39% Rise This Year Is Boeing Stock A Better Pick Over Caterpillar?
  3. Should You Pick Caterpillar Stock At $240 After An Upbeat Q3?
  4. Is Caterpillar Stock A Buy At $290 After A Solid Q2 Beat?
  5. Earnings Beat In The Cards For Caterpillar Stock?
  6. Cross-Sector Comparison: Is Caterpillar Stock A Better Pick Over J&J?

Revenue trend

Currency Devaluation Is A Concern While Fed Rate Hike Does Not Warrant Any Caution

Additionally, the Chinese Central Bank has devalued the Chinese Yuan in response to the economic slowdown and this trend could continue in the near term. This could further impact Caterpillar’s construction industries’ revenue from the Asia Pacific segment due to pressure on product prices in dollar terms. In the last few days, there has been growing speculation on the Federal Reserve hiking rates in December. We believe that a 20 bps hike in Fed rate would have a negligible impact on the company’s valuation and does not warrant any caution on the part of investors.

View Interactive Institutional Research (Powered by Trefis): Global Large Cap | U.S. Mid & Small Cap | European Large & Mid Cap More Trefis Research

Notes:
  1. Caterpillar’s Stock Price Movement, NYSE, November 16, 2015 []
  2. Caterpillar Third Quarter Earnings, Caterpillar, October 22, 2015 []
  3. China GDP Growth Projection, World Bank Database, November 17, 2015 []
  4. Caterpillar Warns Lower Chinese Demand, FT, November 15, 2015 []