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Why? While the Covid-19 outbreak and associated lockdowns resulted in an uncertain outlook for the broader markets, the multi-billion-dollar Fed stimulus announced in late March 2020 helped the markets stage a strong recovery. With vaccination programs underway in multiple countries, investors are now expecting a quicker economic rebound with economies opening up gradually, which will be positive for Caterpillar's business. The company also reported better than expected Q1 numbers.
With the volatility in oil prices in 2020, its production in the U.S. was impacted, resulting in lower dealer inventory levels for Caterpillar. Note that roughly half of the company’s total sales are generated from the North America region. Moreover, the coronavirus outbreak resulted in reduction of mining as well as construction activities in 2020, and the demand is now expected to rebound in 2021.
Caterpillar (CAT) is a leading manufacturer of construction and mining equipment, diesel and natural gas engines, industrial gas turbines and diesel-electric locomotives. Its engines and turbines are primarily focused on power generation, oil drilling and other industrial applications.
The company also sells financial products in the form of financing options of leases and loans and insurance, primarily to drive sales growth of its products. CAT sells its products through a worldwide network of dealers.
Below are key drivers of Caterpillar's value that present opportunities for upside or downside to the current Trefis price estimate for Caterpillar:
Caterpillar’s Energy & Transportation division accounts for nearly 35% of the company's value. This division includes the design, manufacture, marketing and sales of engines, turbines and related parts. Although Caterpillar's market share is relatively modest, the overall market size for these products is huge. This division accounted for about 38% of Caterpillar's Industrial business revenue and 44% of Industrial EBITDA in 2020.
Caterpillar continues to increase its presence in the emerging markets of China, India and Brazil. With the current slowing of China and Brazil economies, the company has witnessed a setback to its top line growth. It has been expanding into these markets to expand product sales and set up manufacturing facilities. Future economic recovery in these markets presents the company a potential opportunity to drive high top line growth for its shareholders.
The 2020 oil price war resulted in lower production in the U.S., which, in turn, led to lower dealer inventory levels for Caterpillar. Note that roughly half of the company’s total sales are generated from the North America region. Moreover, the coronavirus outbreak resulted in reduction of mining activities again impacting Caterpillar's business. The global economy is now expected to see a rebound with vaccination programs underway for several countries, boding well for Caterpillar's business going forward.
The rising population and prosperity in developing nations are driving demand for energy. This is likely to drive growth in demand for engines and turbines used in electric power generation units. Several developing nations such as India are increasing their spending on infrastructure and housing to support their rising urban populations. The increased infrastructure spending may drive growth in construction equipment sales.
Several countries, particularly the developing ones, are witnessing large scale migration of people from rural to urban areas, leading to increased infrastructure spending on roads, bridges and buildings. This is likely to drive growth in demand for engines used in industrial applications.
The Organization of the Petroleum Exporting Countries known as OPEC countries decided to cap their crude oil production later in 2016. This resulted in about 15% increase in crude oil prices within a month. Oil prices remained relatively stable in 2018 as a result of OPEC and Non-OPEC allies sticking to their output agreements. This should result in increased demand for its reciprocating engines and aftermarket spares, thus boosting Caterpillar's sales from its industrial segments which saw huge declines over 2015-16.
The European Union is currently passing through a phase of relatively muted growth but we believe that its growth prospects could take a positive turn because of quantitative easing policies pursued by the European Central Bank. Growth in world trade post the financial crises shall lead to growth in demand for cargo vessels and other commercial ocean vessels. This will drive the growth in demand for engines used in marine applications.
Emerging economies will be leading sources of mining, construction and power related equipment demand. This presents opportunities for several manufacturers including, Caterpillar.
Eastern Europe, with extensive mineable resources, is projected to exhibit an above average growth in mining equipment demand along with the developing areas of Asia, the Africa/Mideast region and Latin America, with the mature markets of Western Europe and North America trailing.
Several developing countries are facing high inflation along side growth. Central banks often resort to raising interest rates to control inflation. The Fed raised interest rates last year, which might lead to a reduced spending on housing because the rate hike gets included in the mortgage interest rates. The same rate hike might cause a deterioration in overall economic activity too. Higher interest rates in turn increase borrowing costs for companies leading to an increase in price of their products. This, dampens demand moderating the growth in market size.
Also, there has been a sudden dip in global commodity prices as a result of Chinese slowdown which in turn has severely impacted commodity dependent nations such as Brazil. We expect the same to impact Caterpillar negatively because a large chunk of its revenues come from emerging countries such as Brazil and China.