30% Downside For Caterpillar Stock?

by Trefis Team
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Despite a 21% decline in Caterpillar’s (NYSE: CAT) stock since the beginning of the year, at the current price of around $114, Caterpillar’s stock could see a significant downside, due to the impact of the coronavirus and oil price war crisis. Caterpillar stock has underperformed the broader markets between 2017 and now. Caterpillar stock is down 23% since the start of 2018, a little over two years ago, as compared to 6% growth for the S&P 500. Our dashboard, ‘Caterpillar Downside: How Low Can Caterpillar Stock Go?‘ provides the key numbers behind our thinking, and we explain more below.

A significant contributor to Caterpillar’s stock price decline over the last two years has been the contraction of its P/E multiple, which on a trailing basis, declined from about 21.4x at the end of 2017 to 13.1x at the end of 2019, and 10.3x currently. The company’s business saw its sales growth plunge to -2% in 2019, after seeing 18% and 20% growth in 2017 and 2018, respectively. This decline was led by lower Energy & Transportation segment revenues. Lower demand for new equipment in the oil & gas industry impacted the segment sales. The stock price in anticipation of 2019 slower sales growth corrected from $160 levels in the beginning of 2018 to $135 levels by June 2019. The stock price later moved up in the second half of 2019 toward $145 levels by the end of 2019.

So what’s the likely trigger and timing to this downside?

The current coronavirus and oil price crisis will likely have a significant impact on Caterpillar’s business, due to an overall decline in demand for equipment in the oil & gas industry. The oil price war led by Saudi Arabia has resulted in more than a 75% plunge in benchmark oil prices, with WTI down from $61 toward the beginning of the year to under $15 levels currently (as of April 24). Lower oil prices will likely result in lower U.S. oil production, thereby impacting the requirement of new equipment as well as servicing. Moreover, with the current COVID-19 pandemic, several cities and industries, including mining, are currently shut down, and this will likely result in lower demand for industrial equipment.

Beyond Energy & Transportation, Caterpillar is also exposed to the construction equipment business. Now real estate is another sector that could see a significant drop due to the economic impact of the current pandemic. Global economy is feared to go into recession, and this will likely impact commercial real estate as well, thus resulting in lower sales for Caterpillar’s Construction Industries segment. As such, we consider a scenario for 2020, with investors revising their expectations for the full-year revenue to be closer to $45.7 billion, about 1% higher than 2017 revenue of $45.5 billion, and 15% lower than the 2019 revenue of $53.8 billion. The market isn’t going to stomach this well, and this is reflected in Caterpillar’s current P/E multiple of 10x, which is 52% lower than 21x level seen toward the end of 2017. This would mean a double whammy of 28% lower earnings and 23% lower P/E multiple, translating into Caterpillar’s price drop of 30%, to about $80 or lower.

Will such a drop be justified? Absolutely not. However, investors who are first out the door in a panic selling situation take a smaller hit to their portfolio. The actual recovery and its timing hinge on the broader containment of the coronavirus spread. Our dashboard forecasting US COVID-19 cases with cross-country comparisons analyzes expected recovery time-frames and possible spread of the virus.

We do believe these trends are likely to reverse over the next few quarters, and as the coronavirus crisis is tamed, higher revenue and earnings expectations will replace the dire scenarios that are easily imagined during difficult times.

Compared to Caterpillar, Johnson Controls stock could decline even more.

Further, our dashboard -28% Coronavirus crash vs. 4 Historic crashes builds a complete macro picture and complements our analyses of the coronavirus outbreak’s impact on a diverse set of companies, including Union Pacific and Adobe. The complete set of coronavirus impact and timing analyses is available here.

See all Trefis Price Estimates and Download Trefis Data here

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