We believe that the Caterpillar stock (NYSE:CAT) looks richly valued at current levels of around $240, and it is vulnerable to downside risk. CAT stock is up 2.7x from the levels of under $90 it was at in March 2020, compared to the S&P which has moved 84%. CAT stock has significantly outperformed the broader markets, primarily due to upbeat results over the recent quarters, improved demand outlook, and a sooner than expected rebound in the economy. However, the stock is up a large 128% in the last one year despite revenue falling 16% y-o-y over the last four quarters. While the gradual opening up of the economy is expected to lead to higher demand for Caterpillar’s equipment, the positives appears to be priced in and CAT stock stock appears to have run ahead of its valuation, in our view. Our dashboard Buy Or Fear Caterpillar Stock provides the key numbers behind our thinking.
Looking at a longer time period, CAT stock is up 88% from levels of $127 seen toward the end of 2018. The rise in stock price over the last two years or so can be attributed to favorable changes in the company’s P/E multiple. Caterpillar’s revenues have trended lower, declining 24% to $41.7 billion in 2020, compared to $54.7 billion in 2018, primarily due to the impact of the Covid-19 pandemic on the demand for its equipment. The impact of the pandemic was visible not only on the top-line but also on margins, due to increased operating costs. The company’s net margins declined to 7.2% in 2020, from 11.2% in 2018. Caterpillar spent close to $9 billion on share repurchases between 2018 and 2020, resulting in a 8% drop in total shares outstanding. As such, on a per share basis, earnings plunged 47% to $5.51 in 2020, compared to $10.39 in 2018. Even if we were to look at adjusted EPS, it declined 42% to $6.56 in 2020, compared to $11.22 in 2018. Despite a large decline in EPS, the company’s P/E multiple expanded from levels of over 12x in 2018 to 33x in 2020. The P/E multiple has further increased to 43x now.
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2020 has not been a great year for Caterpillar’s revenue growth, given the lower demand for equipment across its verticals – construction, resource, and energy & transportation. This can be attributed to the impact of the pandemic on the non-residential construction, and lower demand for energy. That said, the company has seen a rebound in demand, evident from its Q1 2021 results. Caterpillar reported 12% growth in its top-line, led by a solid 26% growth in construction equipment sales. The company reported net margins of 12.9% during the quarter, 80 bps higher compared to 12.1% in the prior year quarter. Now, given that over 46% of the U.S. population has received at least one dose of Covid-19 vaccine, the economy is expected to see a rebound in growth, boding well for Caterpillar’s business. However, the positives appear to be already priced in the current value of $240 per share for CAT.
Caterpillar is expected to post revenues of $49.3 billion in 2021, up 18% y-o-y, while its earnings are expected to grow at a faster pace to $9.75 on a per share and adjusted basis, implying 49% y-o-y growth, led by a strong rebound in margins as well as the impact of share repurchases. At the current price of $240, CAT stock is trading at 25x its 2021 expected EPS of $9.75. This compares with levels of 11x and 13x seen in 2018 and 2019, respectively. In fact, even if we look two years out, CAT stock is trading at 20x its 2022 expected EPS of $11.90. Overall, given the large rally over the last year, and going by the valuation multiple, we believe that CAT stock is now vulnerable to downside risk.