With Caterpillar Stock (NYSE:CAT) not far from its all-time high and up 70%+ over the past year, investors have been wondering whether selling the stock makes for a sensible decision. The giant in construction and mining equipment, diesel and natural gas engines, and heavy machinery currently enjoys a favorable position in its market. Growing spending in construction has led to record demand for its products and services. Meanwhile, Caterpillar’s profit margins hover at record levels. Thus, I remain bullish on the stock.
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Market-Leading Position in Strong Construction Environment
Caterpillar is the market leader when it comes to construction equipment and heavy machinery. Thus, the company inherently benefits from the ongoing strength in global construction. The Infrastructure Investment and Jobs Act passed two years ago is one such catalyst. The Middle East has also been very aggressive in its construction projects, with countries such as the UAE and Saudi Arabia undergoing a continuous transformation. This theme was crystal clear in CAT’s recent financial performance.
In its Q2-2023 results, Caterpillar posted revenue growth of 22% to $17.3 billion. This is the best summer sales result the company has posted since 2012 and the second-best Q2 in its history. This growth was mainly due to improved sales volumes and higher pricing. Sales volumes improved due to rising dealer inventory. Impressively, the company saw double-digit increases in sales and revenues in each of its three primary segments. These three segments made up 98% of total revenues.
- Construction Industries revenues grew by 19%.
- Resource Industries revenues grew by 20%.
- Energy & Transportation revenues grew by 27%.
The notable rise in Energy & Transportation was boosted by favorable factors, including strong demand for turbines and services in the energy sector and successful reciprocating engine sales by Caterpillar. The Power generation sub-segment also saw growth, thanks to a thriving data center sector, while Industrial and Transportation sales also increased significantly. With oil prices currently on the rise, the segment is likely to keep producing exciting results, moving forward.
Unprecedented Margins Drive Record Profits
Following strong revenue growth powered by favorable pricing and higher sales volumes, Caterpillar has been able to experience economies of scale and achieve unprecedented margins. Its adjusted operating profit margin skyrocketed from 13.8% to an unprecedented 21.3% in its most recent quarterly results.
With revenue growth landing at 22% and its adjusted operating profit margin nearly doubling, Caterpillar was able to post a massive 75% rise in adjusted EPS to $5.55. This marked another all-time high quarterly adjusted EPS result for the company.
Capital Returns to Shareholders are on the Rise
With Caterpillar enjoying record profits, management has been comfortable when it comes to providing shareholders with rising capital results. In June, the company once again delivered on its commitment to growing its quarterly dividend. The 8% dividend increase led to its annualized dividend payout rate standing at $5.20. Importantly, this hike marked three full decades of consecutive annual dividend increases!
Excess profits were also allocated to buying back $1.43 billion worth of stock during the quarter, notably more than the $1.1 billion repurchased in Q2 of 2022. Increasing capital returns, bolstered by robust revenue and earnings growth prospects, should continue piquing investor interest in the stock.
Is Caterpillar Overvalued Following Its Rally?
As I mentioned earlier in the article, Caterpillar’s 70%+ one-year surge has resulted in some investors feeling uneasy about holding the stock. At the end of the day, Caterpillar’s business model is highly cyclical. Thus, such a strong rally may signal that the stock has fully realized this up-cycle’s benefits.
That said, I don’t believe that shares are overvalued. This is mainly because the current trends in construction follow multi-year government planning. At the same time, Caterpillar stock is trading at just 13.6 times this year’s expected EPS.
Not only is this multiple below Caterpillar’s historical average, but Wall Street expects that an ongoing favorable environment will persist, expecting further earnings growth in the coming years. Thus, one could argue that Caterpillar’s valuation could even provide a wide margin of safety.
Is CAT Stock a Buy, According to Analysts?
Regarding Wall Street’s view on the stock, Caterpillar has a Moderate Buy consensus rating based on seven Buys, six Holds, and two Sells assigned in the past three months. At $292.15, the average Caterpillar stock price target implies 8.4% upside potential.
If you’re wondering which analyst you should follow if you want to buy and sell CAT stock, the most accurate analyst covering the stock (on a one-year timeframe) is Jamie Cook from Credit Suisse, with an average return of 26.60% per rating and a 77% success rate.
The Takeaway
In conclusion, I believe Caterpillar’s recent surge is not a reason to hit the sell button. The company’s dominant position in the construction and heavy machinery market, coupled with a robust global construction environment and government infrastructure investments, has fueled impressive revenue growth.
Furthermore, Caterpillar’s ability to achieve record margins and profits, along with its commitment to returning capital to shareholders through dividends and buybacks, underscores its financial strength.
While some may question the stock’s valuation after a substantial rally, I believe that Caterpillar remains attractively priced. With a positive outlook for the construction industry and strong earnings growth expectations, I remain bullish on Caterpillar stock.
