Stock Analysis & Ideas

Caterpillar Stock: A Bargain or Dead “CAT” Bounce?

Shares of industrial equipment kingpin Caterpillar (CAT) has seen its relief rally stagnate in recent weeks, with the growth trade now overtaking value in this sudden ricochet off the market bottom.

Although it’s tempting to reach for risk again, I think the cooling-off of value plays like Caterpillar may offer a better entry point for those who doubt the sustainability of the recent relief rally. In any case, CAT stock seems like it could hold more of its value if the current rally proves nothing more than a dead cat bounce (forgive the pun, please).

Indeed, not much has changed at the macro level over the past three weeks. Arguably, all that’s changed is the share price and the inversion of the yield curve.

So, why are investors reaching for growth again? Were they simply oversold?

That could be the case, but regardless, it would only be prudent to stick with a game plan rather than shifting back and forth between risk-on and risk-off after a rotation has already occurred.

While a year-ahead recession does not bode well for some of the more cyclical value plays out there, I think there’s a lot to gain by giving a blue-chip behemoth like Caterpillar the benefit of the doubt.

It’s a Bill Gates favorite for a reason. Like the signature yellow equipment it manufactures, CAT stock may be more durable than meets the eye, given trends working in its favor.

I remain bullish on Caterpillar stock despite the yield curve’s ominous inversion.

Caterpillar Stock: Real Value Hiding in Plain Sight

The cyclical discount on shares of CAT seems implied at these levels. With some of the longer-term catalysts (think longer-term growth in China, the electrification and automation opportunity) still in play, I find it will be hard to keep the firm down for a prolonged period, even if inflationary pressures weigh on Caterpillar’s margins over the near term.

In a rising-rate environment, it’s names like Caterpillar that should be enjoying the most from this recent rally. At around ~$220 per share, the stock trades at 18.6 times trailing earnings and just 2.4 times sales. The company generates actual earnings, and although sales could be choppy, given its greater degree of economic sensitivity, longer-term trends are unlikely to vanish overnight.

Now, buying cyclical stocks can hurt if you get the timing wrong. After a brief plunge into bear market territory from a high of ~$244 per share to a low of ~$187, I think most of the recession jitters are already baked in. Construction equipment demand is really coming back online after waning during the worst of the coronavirus crisis.

Although another recession could push out a big chunk of the demand even further out, it’s hard to ignore management’s ability to swim forward as the tides turn against it. Additionally, there’s a 2%-yielding dividend to collect as you wait for the turbulent macro world to normalize and world economies to get back up and running at full speed.

The China Tailwind is Still in Play

China’s appetite for big-ticket infrastructure purchases could be one of the biggest tailwinds to power CAT stock higher long-term. With the Chinese economy taking another hit from COVID-induced lockdowns and its zero-COVID measures, investors buying Caterpillar for the Chinese tailwind may have to wait a while longer.

The tailwind is still in play, but it’s unclear when fixed-asset growth will power higher again. The coronavirus remains an unpredictable beast, even over two years into this pandemic.

Oil Boom Could Boost Caterpillar’s Energy and Transportation Segment

For now, tailwinds in the oil and gas (O&G) industry could pave the way for increased spending on energy-related offerings. The longer the Ukraine-Russia crisis drags on, the more incentive energy firms will have to ramp up production to capitalize on higher prices.

Although such tailwinds are unlikely to offset the significant slowdown in the Asian region, I don’t think a lot of optimism is baked into shares these days. The China slowdown and the rising risk of recession likely have many weighing the potential downside risks with a name like Caterpillar, even though the firm has already demonstrated its staying power.

Wall Street’s Take

Turning to Wall Street, CAT stock comes in as a Moderate Buy. Out of 14 analyst ratings, there are nine Buy recommendations and five Hold recommendations.

The average Caterpillar price target is $247, implying an upside potential of 14%. Analyst price targets range from a low of $215.00 per share to a high of $290.00 per share.

The Bottom Line on Caterpillar Stock

Cyclical stocks can be quite the rollercoaster ride. Buy them too late in the market cycle, and you could face steep losses.

Still, Caterpillar stock seems too cheap given its resilience through pandemic headwinds thus far. I don’t think it will take much to propel shares towards all-time highs, just shy of the $250 per-share range, if a recession is ultimately avoided or if a “soft landing” is put in place by the Fed amid its tightening cycle.

With a brilliant management team and a powerful longer-term opportunity at hand, it’s wise to look beyond today’s slate of headwinds. Whether it’s China’s economic slowdown, supply chain constraints, or the risk of recession or stagflation, CAT stock seems priced as though a storm is coming when the worst of the storm may already be in the rear-view mirror.

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