We believe that there are several industrial stocks that are currently better valued than Caterpillar (NYSE: CAT). Caterpillar’s current market cap-to-operating income ratio of 31x is much higher than levels of under 23x for SPX Corporation (SPXC), Evoqua Water Technologies (AQUA), LAM Research (LRCX) and Pentair (PNR).
Does this gap in valuation between Caterpillar and its peers make sense? We don’t think so, especially if we look at the fundamentals of these companies. More specifically, we arrive at our conclusion by looking at historical trends in revenues, operating income, and market cap-to-operating income ratio for these companies. Our dashboard Better Bet Than Caterpillar Stock: Pay Less To Get More From SPXC, AQUA, LRCX, PNR has more details – parts of which are summarized below.
1. Revenue Growth
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Caterpillar’s revenue declined at an average rate of 1.2% over the last three years, as compared to revenue growth of 3.1% for SPX, 8.3% for Evoqua, 9.8% for Lam, and 2.0% for Pentair. Even if we look at the revenue growth over the last twelve month period, Caterpillar’s revenue decline of 22% is much worse than revenue growth of 2% each for SPX and Pentair, 4% for Evoqua, and 25% for Lam. Below we discuss what’s driving the revenues for these companies.
- Caterpillar’s business was impacted during the pandemic, as the project timelines and cash flows for real estate developers were affected due to the halt in certain construction activities, while weak oil & gas demand weighed on its energy and transportation business. However, the gradual opening up of economies and resumption of construction activities will aid the company’s revenue growth going forward. In fact, we estimate a low double-digit revenue growth to $46 billion for the company in 2021.
- SPX is into multiple businesses including heating, ventilation, and air conditioning (HVAC), and power transmission and generation among others. The company has seen its top-line expand in 2020 due to the impact of acquisitions of SGS and Patterson-Kelley during 2019 and ULC and Sensors & Software during 2020. The company is expected to see steady revenue growth going forward, led by an increased demand for HVAC, as the Covid-19 crisis winds down.
- Evoqua, a company providing water and wastewater treatment systems and technologies, has seen its revenue expand over the recent years led by growth in aftermarket product revenues as well as increased services revenue. The total sales in 2020, though, declined marginally (1%), primarily due to the impact of the Memcor divestiture. Revenue is expected to see low single-digit growth in the near term, considering the impact of the recent divestiture.
- Lam is known for its semiconductor processing equipment used in the fabrication of integrated circuits worldwide. The company has seen its top-line expand over the recent years led by strong semiconductor demand, even during the pandemic. The growth was seen in several markets including personal computers, 5G, and gaming among others. The company expects the momentum to continue in 2021, and the total sales are estimated to grow a solid 40% in 2021.
- Pentair, a water-treatment company, has seen its revenue expand in low single-digits on average over the last three year period, as well as over the last twelve month period. The company operates in two key segments – 1. Consumer Solutions, which benefited from higher volume in the pool business, as people preferred to invest in pools at homes, given the Covid-19 related restrictions, and 2. Industrial & Flow Technologies, which saw volume decline due to deferment of capital spending, as well as lower aftermarket revenue due to reduced consumption during the pandemic. Now, as the Covid-19 crisis winds down, the company will likely see a pick-up in the Industrial & Flow Technologies segment as well, bolstering the overall top-line growth in the near term.
2. Operating Income Growth
The three-year average operating income growth for Caterpillar stands at 17%, lower than 36% for SPX, 24% for Evoqua, 18% for Lam, and 40% for Pentair. Better revenue growth for the latter three has led to higher operating income for these companies. Looking at the last twelve month period, Caterpillar’s 49% drop in operating income compares with a growth of 21%, 212%, 42%, and 8% for SPX, Evoqua, Lam, and Pentair respectively.
The Net of It All
Although Caterpillar’s revenue base is much larger than SPX, Evoqua, Lam, and Pentair, each of these companies has seen higher growth in revenues and operating income than Caterpillar in the last twelve months as well as the last three-year period. Yet, they appear to be cheaper than Caterpillar. Despite better profit and revenue growth, these companies have a comparatively lower market cap-to-operating income ratio.
Caterpillar’s comparative underperformance in revenue and operating income growth reinforces our conclusion that the stock is expensive compared to some of its peers, and we think this gap in valuation will eventually narrow over time to favor the group of comparatively less expensive names. As such, we believe that SPX, Evoqua, Lam, and Pentair are currently better buying opportunities compared to Caterpillar.
While CAT stock looks comparatively expensive, 2020 has created many pricing discontinuities which can offer attractive trading opportunities. For example, you’ll be surprised how counter-intuitive the stock valuation is for Waste Management vs. Evoqua.