Stock Analysis & Ideas

Caterpillar Stock: Selling Pressure Seems Way Overdone

Shares of iconic yellow-painted machinery maker Caterpillar (CAT) are back on the retreat following the release of some sub-par quarterly earnings results and broader market weakness.

Undoubtedly, Caterpillar may be a value stock. Still, a primary reason behind its below-average multiple is how quickly the big gains or losses can arrive during cyclical upswings and downturns.

Indeed, few investors have the stomach for a cyclical stock over the long run. Despite the cyclical nature, though, I do think Caterpillar is one of the cyclicals that’s worth owning as a part of a long-term portfolio. For now, I am staying bullish on CAT stock.

Believe it or not, there’s a lot of innovation going on behind the scenes. Further, a big recovery in the Chinese market could allow Caterpillar to have upswings to be much larger than the downturns.

That said, investors need a high tolerance for pain and a lengthy time horizon before punching their ticket into a stock that could sag lower for many quarters before the next leg higher.

The current market environment has been quite unkind to the heavy-duty machinery makers. The commodity price surge has weighed on margins, and the outlook for construction and mining seems to be a question mark, as firms curb their appetite for big-ticket fixed assets.

Caterpillar: Better Times Ahead

China woes and COVID supply-side challenge concerns seem overblown at this juncture. Indeed, CAT stock was quick to plunge back into bear market territory following its post-earnings fumble.

Although the fourth-quarter results themselves were underwhelming through the eyes of investors, they actually weren’t as bad as Wall Street’s reaction suggested.

Looking ahead, supply pressures should ease, while demand for construction equipment remains robust. Pro-growth policies in China should give a spark to the cooling Chinese economy, and the U.S. infrastructure bill should also act as a propellant for Caterpillar.

Could it be that CAT stock is pricing in a potential recession, even though the economic road ahead seems smoother? I’d argue it’s likely.

COVID supply issues have weighed heavily, as have higher input costs (or unavailability of specific inputs). Fortunately, Caterpillar remains in a class of its own in heavy-duty machinery.

As a result, I suspect the firm will not see too much demand destruction due to price increases on its top-of-the-line machinery as high levels of inflation persist through 2022 and 2023.

Caterpillar is an iconic brand, and deep-pocketed firms will be likely more than willing to spend a bit more to have best-in-class equipment.

More than Strength of the Economy

Caterpillar will always be a cyclical, economically sensitive company. That said, the firm has the opportunity to leverage next-generation technologies to improve upon its margins and perhaps give customers more of a reason to accelerate their upgrade cycles.

Further, retrofitting with new AI- and data-driven technologies could open up a new revenue stream that could help minimize the blow that inevitably comes with cyclical downturns.

In terms of infrastructure plays, Caterpillar is arguably one of the savviest when it comes to intriguing technologies. Mining autonomy and machinery electrification, in particular, are growth pathways that could power CAT stock steadily higher over the next decade.

Caterpillar’s recent net-zero partnership with gold miner Newmont Corporation (NEM) should not go ignored.

Wall Street’s Take

According to TipRanks, CAT stock comes in as a Moderate Buy. Out of 14 analyst ratings, there are eight Buy recommendations, five Hold recommendations and one Sell recommendation.

The average Caterpillar price target is $236.79, implying an upside of 22.6%. Analyst price targets range from a low of $164 per share to a high of $290 per share.

Bottom Line on CAT Stock

At the end of the day, Caterpillar is looking for high-tech ways to create value for its customers. As long as Caterpillar can help cut costs and improve efficiencies, customers will be more than willing to pay up to acquire such fixed assets.

Many investors may be inclined to shy away from such cyclical stocks. Still, Caterpillar’s tech-savvy is enough reason to consider the name despite its high degree of economic sensitivity.

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