Why Caterpillar’s Stock Rallied To An All Time High

Caterpillar’s (NYSE: CAT) stock price increased nearly 35% in the last 6 months, driven largely by improved margins and improving global sentiment, which could boost global expenditures on infrastructure and mining activities. Metal commodity prices have increased in the last few quarters, which may increase mining activities in the coming years, while energy prices have also improved marginally. The proposed infrastructure legislation in the U.S., if implemented, could greatly boost CAT’s margins and revenues. However, we believe that the market has already priced in these expectations, as the company’s stock is trading at all-time highs. Additionally, the construction growth in China does not look sustainable, as the GDP growth in the region has slowed down considerably, and government support for infrastructure activity will likely follow in the coming quarters. Thus, we believe that although the elevated stock price is justified due to improved market conditions and the company’s cost-cutting measures, there does not appear to be a lot of further upside.

Why The Stock Price Increased 35% In Last Six Months

The downturn in the mining and energy industry resulted in a more than 50% decline in Caterpillar’s EBITDA between 2013 and 2016. The company’s energy and transportation segment was the largest contributor to this decline, as large declines in its oil machinery revenues, coupled with a fairly high fixed cost base, put pressure on its EBITDA. However, commodity prices improved in the last few quarters, and crude oil prices have remained around $50 per barrel in the last year. Additionally, the government support for construction activity in China drove improved sales for the company in the last two quarters. Caterpillar’s restructuring efforts in the last year have also had a positive impact on its margins and profits. A potential infrastructure bill in the U.S. has also fueled optimism among investors.

Can The Stock Go Up Further?

Caterpillar is trading around all time highs, but we don’t see much additional upside for the stock, as we believe that the market has already priced in the aforementioned factors. Oil prices have improved marginally from a year ago, but are still volatile. OPEC countries had a deal last year to cap their production, hoping that prices would improve. However, crude prices remained at similar levels even after 6 months of the deal. Commodity prices, on the other hand, have improved in the last few quarters, which could drive some upside for the company. However, mining equipment sales depend heavily on mining capital expenditures, which require a lot of planning and can fluctuate with volatile commodity prices. Thus, we believe that a substantial near term rebound for mining equipment is fairly unlikely, and the market has already priced in the marginal improvements in the mining space.

The other major factors contributing to Caterpillar’s increased stock price include the proposed tax rate cut and infrastructure bill in the U.S., and increased construction revenues in China. The first two factors are still in preliminary stages at this point – and it’s unclear whether either will even occur, let alone have an impact on Caterpillar. In terms of construction in China, the last two quarters were solid due to government support for construction activities. However, China’s overall growth has slowed down considerably, and we believe that the current construction equipment growth in the region is not sustainable and will come down in the next few quarters.

See our complete analysis of Caterpillar

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