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Caterpillar (CAT)Caterpillar (CAT) is the Ultimate Value Play for Patient Investors
The summer crash hasn't been kind to Caterpillar (CAT: Charts, News, Offers), the construction giant and Dow component that started its slide from $115 per share only five months ago. Shares are now trading near its 52-week low of $72.60, at a cheap 13 times trailing earnings. Caterpillar trades with a forward P/E of 9 and a PEG ratio of 0.65. The company's price/sales ratio of 0.93 also suggests that shares are undervalued, and strong cash flow means that the company's downside at these levels is extremely limited. All of these are strong buy signals for value investors. Bullish technicals signals from ROA, ROI and ROE ratios all suggest that the company is more efficient than its primary rivals at capturing growth. In addition, Caterpillar's dividend yield of 2.5% should appeal to long-term income investors as well.
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Renewed concerns of slowdown in China, Europe and the United States, as well as missed earnings last quarter have all contributed to the crash of this world-renowned industrial company, best known for its construction and mining equipment. Caterpillar's management hasn't been successful at reassuring nervous investors, warning that growth would be slow due to slowdown in Chinese construction. Although Chinese growth is anticipated to be slower than previous years, Caterpillar hasn't given up on the world's second largest economy. Last month, the company announced the opening of a new factory in China, specializing in undercarriage components for its hydraulic excavators.
Also, the company's mountain of debt, with a total debt-to-equity ratio of 256, hurts its growth prospects. Much of the debt is attributed to its $8.8 billion purchase of mining equipment maker Bucryus. Caterpillar has been relying on sales of 5-year notes to stay well capitalized. The company sold $500 million of 5-year notes in July alone. However, if global prospects improve - which is highly probable if the European debt crisis is resolved without too much collateral damage - then Caterpillar won't have any trouble paying off the debt, and shares are likely to rally as a result.
Looking forward, Caterpillar's actions suggest that a recovery may be around the corner. ‘The company has announced that it is restarting its Large Engine Center in Lafayette, a 1.4 million square feet structure which has been closed for the past three years. "We've had quite a comeback, but we're not quite back to the peak," Caterpillar operations manager Timothy Zaspal stated, "We're cautiously optimistic about the future. We're all keeping our eye on economies around the world." In contrast to its previously dour outlook on the Chinese economy, Caterpillar group president Richard Lavin has stated that the company is confident about Chinese growth prospects, despite recent measures to stave off inflation. Lavin stated, "We are optimistic about where our business is going in China over the next five years." Although Chinese orders for its excavators has steadily declined in the past few months, Caterpillar has invested heavily in the expansion of an excavator plant in Xuzhou, which is slated for completion in 2014. Caterpillar claims that when the plant opens, its capacity to build excavators will increase 400% from its 2010 level.
The Xuzhou plant is only the tip of the iceberg, however, as China has been building other plants across the mainland for the construction of machinery, power generation, wheel loaders and small excavators. Caterpillar has also set up a testing ground for machinery in the Jiangsu province. The company now has a Chinese workforce of 8,500 in a dozen manufacturing plants in the country. China is Caterpillar's most valued market, accounting for over half of global demand for construction equipment, but the company faces fierce competition from domestic and foreign rivals. Last year, the company reported that 7% of its annual revenue, or $3.27 billion, came from China.
Infrastructure and mining companies, especially those in Australia, have been betting heavily on Chinese growth to map out their future growth prospects. In addition, Lavin, who moved to Hong Kong last year, believes a recovery in India, the world's second most populous country, will also help the company get back on track in emerging markets. For new investors, Caterpillar's current price is an attractive entry point, as it is likely to rally on any hint of a crisis resolution in Europe as well as better than expected numbers from China or India.
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