Caterpillar, Inc.
Equity Research
Caterpillar, Inc.
Caterpillar is the world’s leading manufacturer of construction
and mining equipment, diesel and natural gas engines,
industrial gas turbines and diesel-electric locomotives.
Caterpillar previously operated in three lines of business:
Machinery, Engines and Financial Products. However, in 2011,
the company shifted their organization into two segments
Machinery and Power Systems and Financial Products.
Machinery and Power Systems Represents the aggregate total
of Construction Industries, Resource Industries and Power
Systems. Financial Products primarily includes Cat Financial
and Caterpillar Insurance Holdings Inc.1
Investment Thesis
I am recommending a BUY rating for Caterpillar, Inc. with a 12month price target of $107.55. This represents a 23.4%
growth potential above the current price of $87.17. The
company has experienced three years of robust sales growth
during a period of economic uncertainty, however, I see a
short term pull back with revenues falling by 10% in 2013.
Date of Report
Recommendation
Ticker
Price Target
Price (July 12, 2013)
Projected Return
July 12, 2013
BUY
CAT
$107.55
S87.17
23.4%
Market Data
Market Capitalization
$57.989B
Shares Outstanding
657.5M
Dividend Yield
2.8%
Dividend
2.4
52 Week Price Range $78.79 - $99.70
105
12-Month Price Performance
100
95
90
85
Opportunities
80
•
•
•
•
75
Caterpillar is undervalued
Outstanding management
Strong economies in emerging markets
Need to replace machinery and power systems in
developed markets
• Mining in the long-term
• Increased government spend on infrastructure
Risks
• Downturn in global economies
• Further negative announcements related to CAT’s business
expansions
• Additional decreases in mining related commodity prices
• Decline in users’ access to capital
• Reduction in government spending on infrastructure
• New emission standards for engines
• Continued strengthening of the U.S. Dollar
• High backlog levels
1
Source: Caterpillar, Inc. 2012 10-K
Financial Summary
Revenue
Operating Margin
EPS
EV/EBITDA
$65.9M
13.0%
$8.48
9.1x
Source: Yahoo Finance
Wade Guzdanski
Research Analyst
guzdanski.2@osu.edu
614.595.9680
SIM Program
Royce West, CFA
Fund Manager
1
Table of Contents
T
Company Overview _________________________________________
3
Business Segments _________________________________________
3
Competition _______________________________________________
5
Competitive Advantages _____________________________________
5
Recent News _______________________________________________
5
Acquisitions _______________________________________________
6
Macroeconomic Outlook _____________________________________
6
Fundamental Drivers ________________________________________
9
Peer Analysis ______________________________________________
10
Financial Analysis ___________________________________________
11
Financial Projection _________________________________________ 13
Valuation _________________________________________________
15
Discounted Cash Flow _______________________________________
17
Recommendation ___________________________________________ 19
2
Company Overview
Caterpillar traces its origins to a 1925 merger of the Holt Manufacturing Company and the C.L.
Best Tractor company, creating a new
entity, Caterpillar Tractor Company. In
2012 Revenue by Geographic Region
1986, the company re-organized itself
under the current name, Caterpillar Inc.
2 From its inception Caterpillar has
enabled economic growth through
31%
innovative farming and infrastructure
United States
equipment. Caterpillar has rapidly
Outside United States
expanded and currently has a
69%
significant global footprint with 69% of
their sales coming from outside the
United Sates.
Source: Caterpillar, Inc. 2012 10-K
Business Segments
In 2011, the company updated their
organization into two segments
Machinery and Power Systems and
Financial Products. Machinery and
Power Systems is comprised of
Construction Industries, Resource
Industries and Power Systems.
Financial products primarily includes
Cat Financial, Caterpillar Insurance
Holdings Inc. (Cat Insurance) and their
respective subsidiaries.3
2012 Revenue by Segment
5% 2%
Construction Industries
29%
32%
Resource Industries
Power Systems
Financial Products
32%
Other
Source: Caterpillar, Inc. 2012 10-K
Construction Industries
Caterpillar’s construction industries segment is primarily responsible for machinery in
infrastructure and building construction applications. The majority of machine sales in this
segment are made in the heavy construction, general construction, mining and quarry and
aggregates markets. The construction industries product portfolio includes the following
machines and related parts: backhoe loaders, compact wheel loaders, small track-type tractors,
small wheel loaders, track-type loaders, medium track-type tractors, skid steer loaders, mini
excavators, select work tools, multi-terrain loaders, small, medium and large track excavators,
motor graders, medium wheel loaders, wheel excavators and pipelayers.4
Resource Industries
The Resource Industries segment is primarily responsible for supporting customers using
machinery in mine and quarry applications. It also serves forestry, paving, tunneling, industrial
and waste customers. The resource industries business was transformed by the acquisition of
Bucyrus International, Inc. (Bucyrus) in July 2011, and now offers mining customers the broadest
2
Source: www.caterpillar.com
Source: Caterpillar, Inc. 2012 10-K
4 Source: Ibid
3
3
product range in the industry. Subsequently the company announced their intention to
transition the Bucyrus distribution business to the independent Caterpillar dealers who support
mining customers.
The Resource Industries product portfolio includes the following machines and related parts:
electric rope shovels, large electric drive mining trucks, industrial swing machines draglines,
tunnel boring equipment, select work tools, hydraulic shovels, large wheel loaders, forestry
products drills, off-highway trucks, paving products, highwall miners, articulated trucks ·
machinery components, underground mining equipment, wheel tractor scrapers, electronics and
control systems, large track-type tractors, wheel dozers, large mining trucks and compactors.5
Power Systems
The Power Systems segment is primarily responsible for supporting customers using
reciprocating engines, turbines and related parts across industries serving electric power,
industrial, petroleum and marine applications as well as rail-related businesses. Power Systems
sales increased globally in 2012, driven by increased customer demand, and included a full year
of sales by MWM Holding GmbH (MWM).
The Power Systems portfolio includes reciprocating engine powered generator sets, integrated
systems used in the electric power generation industry, reciprocating engines and integrated
systems and solutions for the marine and petroleum industries, reciprocating engines supplied
to the industrial industry as well as Caterpillar machinery, turbines and turbine-related services,
diesel-electric locomotives and components and other rail-related products and services.6
Financial Products Segment
The Financial Products segment is primarily driven by Cat Financial, a wholly owned finance
subsidiary of Caterpillar. Cat Financial’s primary business is to provide retail and wholesale
financing alternatives for Caterpillar products to customers and dealers around the world. Retail
financing is primarily comprised of the financing of Caterpillar equipment, machinery and
engines. Cat Financial also provides financing for vehicles, power generation facilities and marine
vessels that, in most cases, incorporate Caterpillar products. In addition to retail financing, Cat
Financial provides wholesale financing to Caterpillar dealers and purchases short-term
receivables from Caterpillar and its subsidiaries. The various financing plans offered by Cat
Financial are primarily designed to increase the opportunity for sales of Caterpillar products and
generate financing income for Cat Financial. A significant portion of Cat Financial’s activities are
conducted in North America, however, Cat Financial has additional offices and subsidiaries in
Asia, Australia, Europe and Latin America.7
Dealers and Distributors
Caterpillar machines are distributed through a worldwide dealer network with 48 locations in
the United States and 141 located outside the United States. In total Caterpillar serves 182
countries and 3,494 places of business, including 1,249 dealer rental outlets. 2 The majority of
the worldwide dealers are independently owned and operated. Standard sales and service
agreements determine rights to purchase and sell products, geographic service territory and
5
Source: Caterpillar, Inc. 2012 10-K
Source: Ibid
7 Source: Ibid
6
4
transactional pricing. The vast reach and long standing relationships Caterpillar has developed
with their dealers significantly outpaces their competitors and is a major source of competitive
advantage.8
Competitors
The competitive environment is fierce and the specific competitors vary across segments. Each
segment is highlighted by large multinational competitors, however, regional competitors also
pose a significant challenge for Caterpillar, especially in China and other emerging markets.
Caterpillar’s major global competitors are as follows:9
Construction Machinery
Komatsu Ltd
Deere & Co.
Volvo Construction Equipment (Volvo Group) Hitachi Construction Machinery Co., Ltd
CNH Global N.V.
J.C. Bamford Ltd
Doosan Infracore Co., Ltd
Hyundai
Resource Industries
Komatsu Ltd
Joy Global Inc.
Wirtgen
Volvo Construction Equipment (Volvo Group) Deere & Co.
Atlas Copco
Hitachi Construction Machinery Co., Ltd
Power Systems
Cummins Inc.
Tognum AG
GE Oil & Gas
GE Power & Water
Volvo Penta (Volvo Group)
Mitsubishi Heavy Industries Ltd.
Deutz AG
Wartsila Corp.
Kirloskar Oil Engines Limited
MAN Diesel & Turbo SE
Siemens Energy
Rolls Royce Group plc
Weichai Power Co., Ltd
Competitive Advantage
The largest competitive advantages for Caterpillar come from the quality of their products,
economies of scale and the supply chain that the company has been able to build over time. The
company focuses on being a leader in everywhere they do business, and in order to generate
superior financial results this must be done on a large scale. Caterpillar has a distribution
network and supply chain that is world class, which provides a significant competitive advantage.
Through economies of scale, Caterpillar is able to produce high quality products at competitive
prices. The benefit of competitive pricing and superior products flows through the network and
results in greater profits for their customers, which in turn drives loyalty and growth.
Recent News
• July 1, 2013 - Caterpillar Inc. announced they have signed a definitive agreement to acquire
Johan Walter Berg AB (Berg), including its core brand of Berg Propulsion. Berg is a leading
manufacturer of mechanically and electrically driven propulsion systems and marine controls
for ships. With the acquisition, Caterpillar will transition from selling only engines and
generators to providing complete marine propulsion package systems.10
9
Source: Caterpillar 2012 10-K
Source: Ibid
11 Source: www.caterpillar.com
10
5
• June 12, 2013 – Caterpillar announced an increase in their quarterly cash dividend by eight
cents to sixty cents ($0.60) per share of common stock, which equates to a 15% increase.11
• April 25, 2013 – Caterpillar announced a $1 billion accelerated stock repurchase program. 12
• April 22, 2013 – Caterpillar revised their guidance for 2013 to reflect revenues in a range of
$57 to $61 billion, with profit per share of about $7.00 compared to their previous outlook
for 2013 revenues of $60 to $68 billion and profit per share of $7.00 to $9.00. 13
Acquisitions
Caterpillar has a history of expansion through acquisition. In addition to the Bucyrus acquisition
mentioned above, below is a list of some of the more significant recent acquisitions:
• August 31, 2011 – Caterpillar Inc. acquired 100% interest in the Pyroban Group Ltd. Pyroban
Group is a leading provider of hazardous area safety solutions to the oil and gas, industrial
material handling, mining and marine markets. The purchase allows Caterpillar Global
Petroleum to offer customers an enhanced range of Cat brand fully-integrated power
solutions and grow its presence in the global hazardous area protection industry. 14
• October 22, 2011 – Caterpillar agreed to buy MWM Holding GmbH, Germany-based
manufacturer of combustion engines for $806 million. MWM is recognized for their
technology and product strength, particularly for its highly efficient range of engines. 15
• June 6, 2012 – Caterpillar Inc. announced the completion of its tender offer for ERA Mining
Machinery Limited, including its wholly-owned subsidiary Zhengzhou Siwei Mechanical &
Electrical Manufacturing Co., Ltd., commonly known as (“Siwei”). ERA manufactures and sells
underground coal mining equipment in mainland China through Siwei. 15
Macroeconomic Outlook
Caterpillar’s operations are materially impacted by conditions in the global economy and the
various capital markets. The demand for their products is cyclical and is significantly impacted by
higher unemployment, lower consumer spending, lower corporate earnings and lower levels of
government and business investment.
The economic situation in the U.S. has been steadily improving since the recent recession and
has shown continued positive signals. Based on recent performance and an improving future
outlook, I am bullish on the economy in the United States in the near term.
11
Source:
Source:
13 Source:
14 Source:
15 Source:
16 Source:
12
www.caterpillar.com
Ibid
Ibid
www.bloomberg.com
Ibid
www.caterpillar.com
6
GDP growth has been positive over
the last few years, however, the first
quarter 2013 rate was revised down
to 1.8% from 2.4%.17 Uncertainty
exists around the monetary policy of
the Federal Reserve, which will
definitely impact the capital market
and economic growth. However, I
expect to see steady growth and
slight expansion continue in the near
term.
Source: Haver Analytics
The U.S. unemployment rate continues to drop from recessionary highs as more people rejoin
the workforce. The steady decrease in the unemployment rate shows that employers are
investing back into their business and are beginning to hire new workers, which helps confirm
the economic recovery trend.
Source: Haver Analytics
Source: Haver Analytics
Companies in the U.S. are
beginning to increase capital
spending as they look past the
recent issues of sequestration and
depressed global growth.
Investment has steadily picked up
since the recessionary lows and is
forecasted to continue in the near
term. The increase in orders for
capital goods is set to drive
revenue growth.
Source: http://research.stlouisfed.org/fred2/series/NEWORDER/)
17
Source: www.bloomberg.com
7
The Federal Reserve’s $85 billion in monthly bond buying helped spur the U.S. housing recovery
and the recovery is starting to take hold. However, recent discussions around whether the
Federal Reserve will begin to taper this buying has raised doubts regarding the stability of the
housing recovery. In the Federal Reserve meeting minutes from June 2013, the Committee
discussed that they should not sell agency mortgage-backed securities (MBS) as part of the
normalization process,18 which suggests that when tapering commences that purchasing will
slow down for Treasury purchases before MBS purchases. The longer it takes for the Federal
Reserve to sell MBS the better it will be for the housing market.
Source: Haver Analytics
Source: Haver Analytics
The foreign macroeconomic outlook is being heavily influenced by the Eurozone debt crisis,
China’s growth slowdown, Japan’s recession and instability in the Middle East and Africa. As the
Eurozone and Japan work to recover from their recessions revenue growth and profitability will
be impacted.
China’s gross domestic product rose 7.5%
for the second quarter 2013., while China’s
12%
industrial production rose 8.9% percent in
10%
June compared to last year. The June
8%
industrial-production growth matched the
6%
slowest pace since the global financial crisis
4%
began.19 China’s June excavator data
2%
showed June sales were down 1% versus
0%
last year and year-to-date sales are down
-2%
12%. Despite this, Caterpillars sales were
-4%
up 35% year over year. While China
-6%
currently makes up a small portion of
Caterpillar’s revenue, China and other
emerging markets are the drivers of future growth.
International GDP Growth Rates
World
East Asia & Pacific
Europe & Central Asia
Latin America &
Caribbean
2008
2009
2010
2011
2012
Middle East & North
Africa
China
Source: www.worldbank.org
In summary, I believe we will continue to see a slow but positive U.S. and global economic
growth in the near term.
18
19
Source: www.bloomberg.com
Source: Jefferies LLC
8
Fundamental Drivers
Trend Analysis
When analyzing a 10 year historical period, Caterpillar’s stock price is highly correlated to the
S&P 500. However, when looking at more recent results, there appears to be no relationship. In
2013 Caterpillar’s stock price has gone in the opposite direction of the greater market. As
evidenced by Caterpillar being up only 8.7% over the last year compared to the S&P 500 which is
up 23.8%. Additionally, Caterpillar’s stock price is currently down over -12% from their 52 week
high in February.20 The market has beat down Caterpillar for its lowered guidance in 2013,
however, the fundamentals are strong and as a result Caterpillar stock is relatively cheap
compared to its upside.
Source: Thompson Reuters - Baseline
Source: Thompson Reuters - Baseline
20
Source: Yahoo Finance
9
Peer Analysis
The charts below provide a comparison of Caterpillar to their industry peers:
PEER ANALYSIS
Company Name
AB Volvo (OM:VOLV B)
AGCO Corporation (NYSE:AGCO)
CNH Global NV (NYSE:CNH)
Cummins Inc. (NYSE:CMI)
Deere & Company (NYSE:DE)
Joy Global, Inc. (NYSE:JOY)
Komatsu Ltd. (TSE:6301)
PACCAR Inc. (NasdaqGS:PCAR)
Terex Corp. (NYSE:TEX)
Caterpillar Inc. (NYSE:CAT)
Market
Capitalization
28,691.0
5,303.6
10,645.6
22,007.8
32,580.2
5,544.8
23,055.0
20,073.6
3,045.8
LTM
Revenue
43,116.9
10,091.6
20,498.0
16,784.0
37,717.0
5,493.9
18,965.6
16,198.7
7,252.1
57,989.4
63,104.0
LTM
Revenues LTM EBITDA
Growth %
Margin %
(10.24%)
6.7%
9.11%
9.5%
2.48%
14.3%
(10.05%)
12.5%
11.73%
16.3%
6.70%
23.5%
(4.88%)
16.2%
(9.24%)
13.4%
2.61%
7.8%
(0.10%)
16.5%
LTM Net
Income
Margin %
2.35%
5.15%
5.85%
8.77%
8.51%
13.28%
6.70%
6.30%
1.47%
7.88%
Source: Capital IQ
PEER ANALYSIS
Company Name
AB Volvo (OM:VOLV B)
AGCO Corporation (NYSE:AGCO)
CNH Global NV (NYSE:CNH)
Cummins Inc. (NYSE:CMI)
Deere & Company (NYSE:DE)
Joy Global, Inc. (NYSE:JOY)
Komatsu Ltd. (TSE:6301)
PACCAR Inc. (NasdaqGS:PCAR)
Terex Corp. (NYSE:TEX)
Caterpillar Inc. (NYSE:CAT)
LTM Total
Debt/EBITDA
7.1x
1.5x
6.4x
0.4x
5.5x
1.1x
2.2x
3.7x
3.7x
P/E LTM
28.3x
10.3x
8.8x
14.9x
10.3x
7.6x
18.1x
19.7x
30.1x
3.9x
11.9x
P/BV LTM
5 Year Beta
5.2x
1.14
3.0x
1.94
1.8x
2.58
3.7x
1.94
4.5x
1.58
6.2x
2.13
2.1x
1.27
3.4x
1.38
10.9x
3.12
7.7x
1.92
Source: Capital IQ
Based on the major competitors analyzed above, Caterpillar is the clear leader in terms of
revenue and market capitalization. Revenue growth varies significantly among the peers as
each company responds to the uncertain global economic environment. Margins appear to vary
depending on company size. With the exception of Joy Global, companies with higher market
capitalizations seem to have the higher margins. Joy Global appears to be a little bit of an
outlier, upon further inspection, Joy Global specializes in resource industries and as indicated in
the next section Caterpillar’s resource industries segment enjoys the highest operating margin of
any of their segments.
10
Financial Analysis
The chart below provides historical financial results for each segment at Caterpillar. Being a
multi-segment business, it is important to analyze the revenue growth and operating margin of
each segment including its contribution to the consolidated financial statements. The company
revised their reportable segments in 2011, therefore, we were unable to obtain the same level
of detail for 2008.
Revenue:
Construction Industries
Resource Industries
Power Systems
Financial Products
Other
Total Revenue
FY 2009
8,507
5,857
13,389
3,139
1,504
32,396
FY 2010
13,572
8,667
15,537
2,946
1,866
42,588
FY 2011
19,667
15,629
20,114
3,003
1,725
60,138
FY 2012
19,334
21,158
21,122
3,090
1,171
65,875
Operating Income:
Construction Industries
Resource Industries
Power Systems
Financial Products
Other
Total Operating Income
FY 2009
(768)
288
1,660
399
(1,002)
577
FY 2010
783
1,789
2,288
429
(1,326)
3,963
FY 2011
2,056
3,334
3,053
587
(1,877)
7,153
FY 2012
1,789
4,318
3,434
763
(1,731)
8,573
Sales Growth:
Construction Industries
Resource Industries
Power Systems
Financial Products
Other
Total Revenue
FY 2009
FY 2010
59.5%
48.0%
16.0%
-6.1%
24.1%
31.5%
FY 2011
44.9%
80.3%
29.5%
1.9%
-7.6%
41.2%
FY 2012
127.3%
261.2%
57.8%
-1.6%
-22.1%
103.3%
Operating Margin:
Construction Industries
Resource Industries
Power Systems
Financial Products
Other
Total Operating Income
FY 2009
-9.0%
4.9%
12.4%
12.7%
-66.6%
1.8%
FY 2010
5.8%
20.6%
14.7%
14.6%
-71.1%
9.3%
FY 2011
10.5%
21.3%
15.2%
19.5%
-108.8%
11.9%
FY 2012
9.3%
20.4%
16.3%
24.7%
-147.8%
13.0%
Source: Caterpillar, Inc. 2012 10-K
Coming out of the recession Caterpillar has experienced tremendous revenue growth and
improved margins. Resource Industries has beat the other segments and has established itself
as the most important segment for Caterpillar.
11
The chart below provides consolidated historical financial results for Caterpillar.
Sales of Machinery and Power Systems
Revenues of Financial Products
Total Revenue
Operating Costs:
Cost Of Goods Sold
Selling General & Admin Exp.
R & D Exp.
Interest Expense of Financal Products
Goodwill Impairment Charge
Other Operating Expense/(Income)
Total Operating Costs
Operating Profit
Interest Expense Excluding Financial Products
Other (Income) Expense
Consolidated Profit Before Taxes
Provision (Benefit) for Income Taxes
Profit of Consolidated Companies
Equity in (Profit) Loss of Unconsolidated Affiliated Companies
(Profit) Loss Attribuatble to Noncontrolling Interests
Profit
Earnings Per Share
Basic EPS
Diluted EPS
FY 2008
48,044.0
3,280.0
51,324.0
FY 2009
29,540.0
2,856.0
32,396.0
FY 2010
39,867.0
2,721.0
42,588.0
FY 2011
57,392.0
2,746.0
60,138.0
FY 2012
63,068.0
2,807.0
65,875.0
38,415.0
4,399.0
1,728.0
1,153.0
1,181.0
46,876.0
4,448.0
274.0
(327.0)
4,501.0
953.0
3,548.0
(37.0)
28.0
3,557.0
23,886.0
3,645.0
1,421.0
1,045.0
1,822.0
31,819.0
577.0
389.0
(381.0)
569.0
(270.0)
839.0
12.0
(68.0)
895.0
30,367.0
4,248.0
1,905.0
914.0
1,191.0
38,625.0
3,963.0
343.0
(130.0)
3,750.0
968.0
2,782.0
24.0
58.0
2,700.0
43,578.0
5,203.0
2,297.0
826.0
1,081.0
52,985.0
7,153.0
396.0
32.0
6,725.0
1,720.0
5,005.0
24.0
53.0
4,928.0
47,055.0
5,919.0
2,466.0
797.0
580.0
485.0
57,302.0
8,573.0
467.0
(130.0)
8,236.0
2,528.0
5,708.0
(14.0)
41.0
5,681.0
$ 5.83
$ 5.66
$ 1.45
$ 1.43
$ 4.28
$ 4.15
$ 7.64
$ 7.40
$ 8.71
$ 8.48
Source: Caterpillar, Inc. 2012 10-K
Caterpillar experienced a significant drop in profitability during 2009, however, has successfully
rebounded during the last 3 years. Margins, profit dollars and earnings per share continue to
increase as Caterpillar executes their disciplined growth strategy. In addition to short-term
profitability, the company has invested significant amounts of capital to support future growth
initiatives. Capital expenditures have increased each year since 2009 with an incremental $835
million being spent in 2012. The company has issued guidance that 2013 capital expenditures
will be $3.4 billion. Research and development expense has also increased steadily over the past
four years.
The Company has derived some of their savings by leveraging their expenses, specifically selling,
general and administrative (SG&A). While total SG&A dollars have increased the company has
leveraged their sales increase to reduce the SG&A as a percent of sales. In 2012 the company
incurred a $580 million impairment charge related to their acquisition of ERA Mining Machinery
Limited, Siwei. This write-off almost equals the purchase price of $653 million. With the
number of acquisitions that Caterpillar executes it is critical that no other investments turnout as
poorly as this one did.
12
Financial Projections
The chart below provides projected financial results for Caterpillar:
Sales Growth:
Construction Industries
Resource Industries
Power Systems
Financial Products
Other
Total Revenue
FY 2012
FY 2013E FY 2014E FY 2015E
-1.7%
9.0%
8.0%
8.0%
35.4%
-50.0%
4.0%
15.0%
5.0%
9.0%
8.0%
8.0%
2.9%
5.0%
6.0%
7.0%
-32.1%
0.0%
0.0%
0.0%
9.5%
-10.3%
7.0%
9.0%
Operating Margin:
Construction Industries
Resource Industries
Power Systems
Financial Products
Other
Total Operating Income
FY 2012
FY 2013E FY 2014E FY 2015E
9.3%
10.0%
10.5%
11.0%
20.4%
18.0%
20.0%
21.5%
16.3%
16.0%
16.3%
16.5%
24.7%
20.0%
24.0%
25.0%
-147.8%
-100.0%
-100.0%
-100.0%
13.0%
12.1%
13.1%
13.9%
Caterpillar’s projected revenues are significantly impacted by the downturn in the Resource
Industries segment. Decreases in commodity prices, especially iron ore, have triggered a
significant decrease in the demand for mining equipment. Our 2013 revenue forecast includes a
50% decline for the Resource Industries which matches the companies revised guidance from
April 22, 2013. Sales growth for the remaining segments were determined based on historical
growth factors and analysis of consensus revenue data.
In terms of operating margins, even with the slowdown in the economy Caterpillar was able to
effectively manage their margins. The company has observed steady improvements in the last
three years, therefore, we projected similar year over year improvements with the exception of
2013 (due to 50% decrease in revenue from the Resource Industries segment). The operating
margin for 2013 was projected to decrease 90 basis points to 12.1% due to the sudden decrease
in Resource Industries revenue. The projected margins for the other segments improve slightly
as I anticipate the company will continue to identify operational efficiencies and effective cost
savings.
13
The chart below provides projected consolidated financial results from Caterpillar:
Sales of Machinery and Power Systems
Revenues of Financial Products
Total Revenue
Total Operating Costs
Operating Profit
Interest Expense Excluding Financial Products
Other (Income) Expense
Consolidated Profit Before Taxes
Provision (Benefit) for Income Taxes
Profit of Consolidated Companies
Equity in (Profit) Loss of Unconsolidated Affiliated Companies
(Profit) Loss Attribuatble to Noncontrolling Interests
Profit
Earnings Per Share
Diluted EPS
Consensus
Guidance
FY 2013E
55,847.0
3,244.5
59,091.5
51,918.3
7,173.2
472.7
(118.2)
6,818.7
2,045.6
4,773.1
4.7
59.1
4,709.2
FY 2014E
59,798.0
3,439.2
63,237.1
54,952.0
8,285.2
442.7
(126.5)
7,969.0
2,390.7
5,578.3
5.1
63.2
5,510.0
FY 2015E
65,258.3
3,679.9
68,938.2
59,334.1
9,604.1
482.6
(137.9)
9,259.4
2,777.8
6,481.6
5.5
68.9
6,407.1
$ 6.96
$ 6.94
$ 7.00
$ 8.06
$ 8.05
$ 9.28
$ 9.27
Projected revenues and operating margins were determined based on projecting segment level
results. All line items below operating profit were projected primarily based on analysis of
historical trends. Based on our projections, we see EPS improving by 33% over the next three
years.
Revenue Growth Trend
80,000
70,000
60,000
50,000
40,000
30,000
20,000
10,000
FY 2008 FY 2009 FY 2010 FY 2011 FY 2012 FY 2013E FY 2014E FY 2015E
Revenue
14
Valuation
Sector Valuation
The table below provides valuation multiples for the Industrials Sector on an absolute basis and
relative to the S&P 500. Valuation analysis is based on ten years of financial history.
Industrials Sector Valuation
Absolute Basis
P/Trailing E
P/Forward E
P/B
P/S
P/CF
High
Relative to SP500
P/Trailing E
P/Forward E
P/B
P/S
P/CF
High
Low
24
20.9
3.6
1.6
14
Median
Current
7.1
17.6
16.4
9.2
16
15.1
1.4
3
3
0.6
1.3
1.3
6
10.7
11.2
Low
1.2
1.2
1.3
1.1
1.2
Median
0.66
0.84
0.9
0.8
0.8
Current
1.1
1
1.1
1
1.1
1
1
1.2
0.9
1.1
Source: Thompson Reuters - Baseline
The price of the sector appears to be relatively inline, possibly slightly cheap, when compared to
the market. This was determined by looking at current valuations relative to their history. Price
to forward earnings and price to cash flow are inline as their current valuation relative to the
market matches the 10 year median. Price to trailing earnings and price to sales are slightly
cheap and price to book is at a slight premium. The net of these valuations would suggest the
sector valuation is inline.
Industry Valuation
The table below provides valuation multiples for the Machinery, Construction and Farming
Industry on an absolute basis and relative to the S&P 500. Valuation analysis is based on ten
years of financial history.
Machinery Construction/Farming Industry Valuation
Absolute Basis
P/Trailing E
P/Forward E
P/B
P/S
P/CF
High
Relative to SP500
P/Trailing E
P/Forward E
P/B
P/S
P/CF
High
Low
31
36.1
6.3
1.7
14.5
5.2
6.7
1.5
0.3
4.8
Median
Current
14.3
12.1
13
11.9
4
3.4
1
1
8.8
8.3
0.48
0.56
1.1
0.5
0.6
Median
Current
0.91
0.77
0.9
0.8
1.4
1.4
0.7
0.7
0.9
0.8
Low
1.8
2.2
2.6
1.3
1.5
Source: Thompson Reuters - Baseline
15
The industry appears to be relatively cheap when compared to the market. Price to forward
earnings, trailing earnings and cash flow are currently at ratios less than the median for the past
10 years. Price to book and price to sales are both inline. To understand if these results are
skewed due to changes in growth or risk, I also looked that the ratios over the past 5 years
noting the results were consistent with the figures shown above.
Caterpillar Valuation
The table below provides valuation multiples for Caterpillar on an absolute basis and relative to
the S&P 500. Valuation analysis is based on ten years of financial history.
Caterpillar Valuation
Relative to Industry
P/Trailing E
P/Forward E
P/B
P/S
P/CF
High
Relative to S&P 500
P/Trailing E
P/Forward E
P/B
P/S
P/CF
High
Low
1.3
1.5
2
1.7
1.5
0.81
0.74
0.8
0.8
0.5
Low
2.1
2.6
2.7
1.3
1.6
Median
Current
1
0.93
0.99
1
1.2
0.9
1
0.9
1
0.9
Median
Current
0.41
0.95
0.71
0.61
0.86
0.8
1.1
1.9
1.3
0.4
0.8
0.6
0.4
0.9
0.7
Source: Thompson Reuters - Baseline
Absolute Valuation
A.
P/Forward E
P/S
P/B
P/EBITDA
P/CF
High
B.
40.1
1.7
7.4
15.48
14.2
Low
C.
7.3
0.3
2.4
2.23
2.8
Median
Current
D.
12.7
1.2
4.6
7.44
9.7
E.
11.9
0.9
3.1
5.44
7.2
Target
Multiple
F.
11.9
1.1
4
6.8
8.2
Target
Earnings
G.
8.05
Target Price
(F x G)
H.
95.8
106.05
111.96
108.46
98.82
This final view of the valuation of Caterpillar indicates that the stock is relatively cheap. When
compared to the industry four of the five current ratios are less than the median. The story is
even worse when compared to the market with all five current ratios being less than the
median. As a result, I used target multiples between the current and median ratios which
reflects the undervalue of the stock. Based on my target multiples the target price for
Caterpillar ranges from $96 to $112.
16
Discounted Cash Flow
To better analyze the price target for Caterpillar we performed a discounted cash flow model.
The below model shows the detailed behind our discounted cash flow model:
Terminal Discount Rate =
Terminal FCF Growth =
Year
11.0%
3.5%
2013E
2014E
2015E
2016E
2017E
2018E
2019E
2020E
2021E
59,092
-10.3%
63,237
7.0%
68,938
9.0%
73,074
6.0%
77,459
6.0%
81,719
5.5%
86,214
5.5%
90,524
5.0%
95,051
5.0%
99,328 103,301
4.5%
4.0%
Operating Margin
Operating Margin
7,173
12.1%
8,285
13.1%
9,604
13.9%
9,865
13.5%
10,302
13.3%
10,705
13.1%
11,122
12.9%
11,497
12.7%
11,881
12.5%
12,118
12.2%
12,396
12.0%
Interest and Other
Interest % of Sales
355
0.6%
316
0.5%
345
0.5%
365
0.5%
387
0.5%
409
0.5%
431
0.5%
453
0.5%
475
0.5%
497
0.5%
517
0.5%
2,046
30.0%
2,391
30.0%
2,778
30.0%
2,850
30.0%
2,974
30.0%
3,089
30.0%
3,207
30.0%
3,313
30.0%
3,422
30.0%
3,486
30.0%
3,564
30.0%
Profit (Loss) of Unconsolidated Affiliates
64& NCI 68
% of Sales
0.1%
0.1%
74
0.1%
79
0.1%
84
0.1%
88
0.1%
93
0.1%
98
0.1%
103
0.1%
107
0.1%
112
0.1%
Revenue
% Growth
Taxes
Tax Rate
2022E
2023E
Net Income
% Growth
4,709
-17.1%
5,510
17.0%
6,407
16.3%
6,571
2.6%
6,857
4.3%
7,119
3.8%
7,390
3.8%
7,633
3.3%
7,882
3.3%
8,028
1.9%
8,204
2.2%
Add Depreciation/Amort
% of Sales
Plus/(minus) Changes WC
% of Sales
Subtract Cap Ex
Capex % of sales
2,836
4.8%
6,473
11.0%
3,400
5.8%
2,846
4.5%
(544)
-0.9%
3,162
5.0%
2,964
4.3%
(588)
-0.9%
2,964
4.3%
3,142
4.3%
(1,315)
-1.8%
3,142
4.3%
3,331
4.3%
(1,394)
-1.8%
3,331
4.3%
3,514
4.3%
(1,471)
-1.8%
3,514
4.3%
3,707
4.3%
(1,552)
-1.8%
3,707
4.3%
3,802
4.2%
(1,629)
-1.8%
3,802
4.2%
3,992
4.2%
(1,711)
-1.8%
3,992
4.2%
4,172
4.2%
(1,788)
-1.8%
4,172
4.2%
4,339
4.2%
(1,859)
-1.8%
4,339
4.2%
Free Cash Flow
% Growth
10,619
512.4%
4,650
-56.2%
5,819
25.1%
5,256
-9.7%
5,462
3.9%
5,648
3.4%
5,838
3.4%
6,004
2.8%
6,171
2.8%
6,240
1.1%
6,345
1.7%
NPV of Cash Flows
NPV of terminal value
Projected Equity Value
Free Cash Flow Yield
34,367
30,836
65,204
18.00%
53%
47%
100%
Terminal Value
87,558
Free Cash Yield
7.25%
12.5
13.8
8.6
9.3
12.0
13.2
8.9
9.6
Terminal P/E
10.7
Terminal EV/EBITDA
6.9
Current P/E
Projected P/E
Current EV/EBITDA
Projected EV/EBITDA
Shares Outstanding
Current Price
Implied equity value/share
Upside/(Downside) to DCF
Debt
Cash
Cash/share
10.4
11.5
7.6
8.1
676.6
$ 87.17
$ 96.37
10.6%
33,039
5,490
8.11
17
Assumptions
My discounted cash flow model provides an estimated implied value for Caterpillar of $107.55
or a 23.4% increase from the current stock price. This is consistent with the target range of $96 $112 based on multiple valuation. The key assumptions used in the calculation of my model are
as follows:
• The terminal growth rate for the S&P 500 is approximately 3.5%. The industrials
sector and Caterpillar specifically require slightly higher grow rates, therefore, I
added 50 basis points and used a rate of 4%. This decision was driven by Caterpillar
consistent history of performance combined with the higher growth rates expected in
emerging markets.
• A discount rate is used to adjust the value of forecasted cash flows for risk that may
not materialize. A typical discount rate of 10.0% is used as a market average.
Caterpillar is a cyclical company with some volatility, therefore, I added 50 basis
points and used a discount rate of 10.5%.
Sensitivity Analysis
The two main assumptions that drive the final discounted cash flow value are the terminal
growth rate and discount rate. To understand the range of impact when changing these
assumptions I created a sensitivity table that shows the sensitivity of the price to these two
factors. I analyzed a 50 basis point swing in each direction for each factor. The range given in
the sensitivity table below shows possible prices between $94.39 and $122.50. In terms of
growth potential, this sensitivity analysis represents a range of 11% - 41% growth.
Discount Rate
Terminal
Growth Rate
10.00% 10.25% 10.50% 10.75% 11.00%
3.50%
111.4
107.2
103.4
99.7
96.4
3.75%
113.8
109.4
105.4
101.6
98.1
4.00%
116.5
111.8
107.6
103.6
99.9
4.25%
119.4
114.4
109.9
105.7
101.8
4.50%
122.5
117.3
112.4
108.0
103.9
18
Recommendation
Based on the analysis in this report, I am initiating coverage on Caterpillar, Inc. with a BUY
rating and a price target of $107.55. This price target would give an expected price appreciation
of 23.4%. When combined with the dividend income of $2.40, total expected return is 26.0%.
Caterpillar is well positioned as the leader in the industry and will be able to drive revenue,
profitability and market share in both the short-term and long-term. Below is a listing of
opportunities and risks associated with this recommendation.
Opportunities
•
•
•
•
•
•
Caterpillar is undervalued
Outstanding management
Strong economies in emerging markets
Need to replace machinery and power systems in developed markets
Mining in the long-term
Increased government spend on infrastructure
Risks
•
•
•
•
•
•
•
•
Downturn in global economies
Further negative announcements related to CAT’s business expansions
Additional decreases in mining related commodity prices
Decline in users’ access to capital
Reduction in government spending on infrastructure
New emission standards for engines
Continued strengthening of the U.S. Dollar
High backlog levels
Analyst Certification
I, Wade Guzdanski, hereby certify that the views expressed in this research report accurately
reflect my personal views about the subject security. I also certify that no part of my
compensation was, is, or will be directly or indirectly, related to the specific recommendation or
view expressed in this research report.
19