Stock Analysis & Ideas

Caterpillar: A Potential Beneficiary of High Inflation

Caterpillar (CAT) is a company that manufactures and sells heavy machinery. The company is potentially well positioned for an inflationary environment. Regardless, we are neutral on the stock as its valuation does not provide a large margin of safety.

Measuring Caterpillar’s Operating Efficiency

Companies like Caterpillar need to hold on to high amounts of inventory to keep the business running. For this reason, the speed at which a company can move inventory and convert it into cash is critical in predicting its success. To measure Caterpillar’s efficiency, we will use the cash conversion cycle, which shows how many days it takes to convert inventory into cash. It is calculated as follows:

CCC = Days Inventory Outstanding + Days Sales Outstanding – Days Payables Outstanding

Caterpillar’s cash conversion cycle is 113 days, meaning it takes the company 113 days for it to convert its inventory into cash. In the past several years, this number has been volatile, given the cyclical nature of the business.

The company’s efficiency has ranged from a low of 93 days in 2018 to a high of 135 days in 2020 over the past decade. Compared to the industrial sector, CAT’s cash conversion cycle is higher than that of the sector average of 65 days. Although not ideal, it’s not a cause for concern.

In addition to the cash conversion cycle, let’s also take a look at Caterpillar’s gross margin trends. Ideally, we would like to see a company’s margins expand each year. This is, of course, unless gross margins are already very high, in which case it is acceptable for them to remain flat and stable.

Once again, the company’s cyclical nature makes gross profit margin volatile. Nonetheless, margins have remained consistently above 20% in the last decade, with a low of 21.1% in 2016 and a high of 27.2% in 2018. As a result, we don’t believe competition has been eating away at CAT’s profitability.

Growth Catalysts

Throughout the past year, commodities prices have been skyrocketing due to strong demand relative to supply. In addition, inflation is at its highest level in decades. Fortunately, Caterpillar is positioned well for this type of environment.

Given that the company sells heavy machinery specifically for energy, resource, and construction industries, higher commodities prices should translate to higher demand for its products.

Furthermore, since CAT’s customers are dependent on its products and are also seeing larger profits, it will be able to easily pass on any increased production costs related to inflation. Thus, Caterpillar can potentially act as an inflation hedge as long as the Federal Reserve doesn’t hike rates too quickly.


Just as commodities prices can be a tailwind for Caterpillar, they can also be a risk. Prices can fluctuate rapidly and suddenly fall. In such a situation, demand for its products will fall as its customers will become less profitable.

However, there are other risks associated with Caterpillar. According to TipRanks’ Risk Analysis, the company has disclosed 26 risks in its most recent earnings report. The highest amount of risk came from the Macro & Political category.

Wall Street’s Take

Turning to Wall Street, Caterpillar has a Moderate Buy consensus rating, based on eight Buys, five Holds, and one Sell assigned in the past three months. The average Caterpillar price target of $236.79 implies 23.36% upside potential.

Analyst price targets range from a low of $164 per share to a high of $290 per share.

Final Thoughts

Caterpillar is an industry leader that can potentially benefit from the current inflationary environment. In addition, analysts see over 23% upside potential in the stock price. Nonetheless, we remain neutral because the 23% upside doesn’t provide enough margin of safety to compensate for the company’s cyclical nature.

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