Stock Analysis & Ideas

Why Caterpillar Stock May Fare Better in the Next Recession

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Caterpillar may be a stock to be avoided in the face of a recession. However, as mining and energy sectors remain strong while management focuses on innovation and margin-enhancing efforts, Caterpillar could come out ahead of broader markets through the next downturn.

Shares of heavy-duty equipment maker Caterpillar (CAT) typically lead the charge lower at the first signs of recession. Demand for big-ticket equipment tends to dissipate quickly when construction firms look to trim away at costs. Indeed, Caterpillar has been one of the cyclicals that have amplified the market’s downside in the face of severe recessions.

While Caterpillar stock’s performance in prior recessions leaves a lot to be desired, I think there’s a lot to love about the firm this time around.

Undoubtedly, the “things are different this time around” mantra can be dangerous for investors. However, it’s worth noting that every downturn is different in nature, and this one, I believe, could dampen the potential downside. For that reason, I remain bullish on CAT stock.

On TipRanks, CAT scores an 8 out of 10 on the Smart Score spectrum. This indicates a potential for the stock to outperform the broader market.

Why the Next Recession May Not Be as Catastrophic for Caterpillar

As the Fed pushes the economy on edge with every interest rate hike, there’s fear that a hard landing for the economy could occur.

Still, a repeat of the Great Financial Crisis of 2008 should not be expected. Further, the unique characteristics of this macro environment may actually help CAT stock hold its own and act more as a resilient play in the face of macroeconomic turmoil.

Alternatively, the recent boom in commodity prices has been a massive boon to the mining sector.

Many miners are suddenly raking in considerable amounts of cash flow. If such commodities stay elevated, many may become cash cows with enough capital to ramp up capital spending while rewarding shareholders with generous dividend hikes. Indeed, such a commodity price surge could bolster the demand for Caterpillar’s mining equipment, even if the rest of the economy tips into a modest downturn.

It’s not a mystery why Caterpillar’s CEO does not expect a slowdown as recession fears rise, even as other firms slow on hiring practices. Demand for Caterpillar’s trusted equipment is too strong, and it could stay that way as the company looks to iron out the kinks in the supply chain.

It’s not just hot commodities that could spare Caterpillar stock from excessive damage, come the next recession. The company’s investment in technology and the long-term electrification trend could also work in the firm’s favor.

Demand Stays Remarkably Resilient

Bank of America (BAC) analyst Michael Ferniger recently hiked his CAT stock price target to $224 from $215, citing “no signs of a slowdown from customers” and “tech investments.” Despite the price target raise, Feniger retains a Neutral rating on the stock, given the new target implies a meager amount of upside from current levels.

No signs of waning consumer demand yet. And tech efforts could help further boost demand. Undoubtedly, the coming recession could prove to be a weird one. Given most of the layoffs have been focused in the hard-hit tech sector (especially in startups), it’s possible that shockwaves don’t necessarily heavily impact other sectors, like Industrials.

For now, I think it’s quite possible that potential demand tailwinds can more than offset recessionary pressures, which tend to weigh most heavily on Industrials.

Caterpillar Stock Still Looks Cheap

Amid a sell-off targeting high-multiple stocks, Caterpillar has proven to be a relative safe haven. The stock remains modestly valued at a mere 18.6 times trailing earnings. The 2% dividend yield is also a big draw to the stock amid the recent rush to profitable companies that generate meaningful cash flows.

Though demand could weaken over coming quarters if we inch closer to a recession, it’s hard to imagine such a scenario with commodity prices at these heights. The mining and energy products, in particular, could be major bright spots for the firm.

In an upbeat investor day presentation, management retained its free cash flow and margin targets. Investments in tech could apply upward pressure on margins. And if supply-side headwinds fade quicker while demand stays strong, there’s a good chance that margins could overshoot.

In any case, Caterpillar is a great company that’s not on the same fragile legs it was on back in 2007.

Wall Street’s Take

According to TipRanks’ analyst rating consensus, CAT stock comes in as a Moderate Buy. Out of 15 analyst ratings, there are 11 Buy recommendations, two Hold recommendations, and two Sell recommendations.

The average Caterpillar price target is $240.93, implying an upside of 6.09%. Analyst price targets range from a low of $164 per share to a high of $282 per share.

The Bottom Line on Caterpillar Stock

It’s hard not to love Caterpillar stock, as management looks to raise the bar on margins while looking to meet high demand for its equipment. Add a sustainability focus, tech investments, and strength in the mining and energy sectors into the equation, and the long-term fundamentals seem too good to pass up on, even in the face of a recession.

Indeed, Caterpillar is in much better shape ahead of an economic slowdown that could prove less hostile than the one suffered 14 years ago.

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