Is Caterpillar’s Increased Stock Price Warranted?

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Following Donald Trump’s victory in U.S. presidential election, the stocks of U.S. construction equipment manufacturers Caterpillar (NYSE: CAT) and Deere  (NYSE: DE) stocks rose sharply on expectations of increased infrastructure spending by the U.S. government. The President-elect reiterated his view of increasing U.S. government infrastructure spending in his victory speech which resulted in stock price rise of Caterpillar by about 10%. We believe, however, that Caterpillar’s stock price is overvalued, as any improvement in the construction industry is unlikely in the short term. This is despite the belief that the governmentspending on infrastructure will increase during the Trump presidency. The construction industry still has to face the challenges of lower used inventory prices, stiff competition among equipment manufacturers, and global economic uncertainties, all of which will obstruct the short-term recovery in the industry. However, the construction industry is headed for a long-term growth driven by long-term fundamentals of increasing population and urbanization.

Construction Industry Headed For a Slowdown in 2017

The global construction equipment industry has witnessed a slowdown over the last couple of years due to weakness in commodity prices worldwide and a slowdown of the Chinese economy. Although construction companies stock went up after Trump’s victory, the underlying trend is still negative.  We note industry observers believe that the industry is headed for another slowdown in the second half of 2017 due to increasing raw material and labor costs, stiff lending rules of banks and uncertainty around government construction spending, especially in the U.S. and Europe. Additionally, increased competition among equipment manufacturers and lower used equipment prices are likely to result in the decline of construction equipment sales.

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The current economic uncertainties in the European Union and the United Kingdom caused by the Brexit vote are likely to impact the construction equipment industry on the continent. The European Union has stalled its funding to Poland due to the ongoing disagreements over Poland’s state of democracy, which was the largest receiver of EU funding for the period 2012-15, leading to a decline in construction industry output in Poland. The seller confidence in the U.K. is also low, because about 55% of U.K. imports are from other EU countries and 45% of UK exports are to EU countries.  Moreover, uncertainty exists as to the trade model that the U.K. will ultimately adopt. Additionally, U.K. will lose out on investments from the EU, which could lead to decreased industrial output. We note that the European Central Bank invested about EUR 5.5 billion in U.K. infrastructure projects in 2015.

 

Construction Industry is Likely to Rebound post-2018

The U.S. government’s total public capital spending, which includes infrastructure spending, was just about 3.4% of U.S. GDP in 2015 — the lowest in more than 60 years. According to the American Society of Civil Engineers, the backlog of infrastructure projects is expected to cost US$3.6 trillion by 2020 which is likely to result in significant growth in construction output. We also expect a recovery in crude oil prices to gain momentum next year, now that OPEC countries have agreed to cap their oil production.

The Asia Pacific region will drive the construction industry growth further in the coming years as about $1.1 trillion worth construction projects are standing in the pipeline according to CIC estimates. If the Chinese economy resumes its prior growth rate in coming year, the construction industry will have further growth potential.

 

Notes:

1) The purpose of these analyses is to help readers focus on a few important things. We hope such lean communication sparks thinking, and encourages readers to comment and ask questions on the comment section, or email content@trefis.com

2) Figures mentioned are approximate values to help our readers remember the key concepts more intuitively. For precise figures, please refer to our complete analysis of Caterpillar

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