Connect with us

Caterpillar (CAT) Stock Analysis 2021 [Is $CAT a Buy?]


Caterpillar (CAT) Stock Analysis 2021 [Is $CAT a Buy?]

Hey, what’s up guys! In this video, I’m going to check out the stock of Caterpillar. I’m going to use financial statement analysis, going to look at their balance sheet, check out their profitability, use an intrinsic valuation model, and ultimately decide whether it’s a good time to buy their stock or not.

Alright, let’s jump into it. Alright guys, you know about Caterpillar. Here is what they build here. You can see they build a variety of vehicles and equipment, and they really serve a lot of industries more than just construction. They’re also a big player in the oil and gas industry, and they’ve got their hands on solar.

So if you’re curious about where they make their money, you saw their products, but as far as what percentage, Construction Industries is their biggest segment, this is stuff like asphalt, pavers, backhoe loaders, large truck, excavators, harvesters, tractors things like that.

In the green you’ve got Energy and Transportation Industry at 34%, this primarily serves the oil and gas industry customers, we saw the solar going on there. 18% of the revenues come from Resource Industries, these primarily serve the mining industry, you’ve got large mining trucks, hard rock vehicles, long wall miners, and things like that.

They also have financial products, they make money financing the purchase of some of their expensive vehicles. So as far as where they generate revenues, they are U.S.-based companies, so primarily you’ve got North America there, 47% of the revenues.

But they’re actually pretty well diversified with Asia Pacific, accounting for 23%. In Europe, Middle East, and Africa with 22%. Here’s a quick look at their stock.

As you can see it’s gone up about 40% in the past year. If you look at the 10-year chart, you can see it’s gone up about 91%, so kind of erratic growth there. It’s kind of gone nowhere for years sometimes, but other times it’s really exploded. It’s currently trading about 24.5 times next period’s earnings, making it a pretty rich valuation.

But it is a very solid, stable company, everyone knows Caterpillar. Their dividend yield is about 2.08% which is something. It’s about 107 billion dollar company right now. Alright, here’s a few quick stats on Caterpillar’s balance sheet.

They have considerable leverage there, with 80% liabilities to assets ratio. Now not a lot of that is long-term debt, you can see the much lower debt to assets ratio, but it is long-term liabilities, so it amounts to the same thing, they are pretty highly levered. The current ratio is about 1.5 which is pretty healthy, that means their current assets are about 1.5 times their current liabilities, they’re really in no danger there.

And the quick ratio is just fine as well. By the way, if you don’t know any of these ratios, check them out in the description below. Interest coverage ratio is a little bit low there 8.9%, so what that means is that their interest expense is really eating into their profits there.

Their earnings before taxes and interest can only cover their interest 8.9 times, I really don’t like to see that, and I’m going to have a look at their income statement and see whether that’s temporarily high, maybe they have lower earnings than usual, or if that’s generally high.

So, here I’m looking at their income statements for the past couple years, and what I see here is that they managed to achieve about six billion dollars of net income in 2018 and 2019 before getting cut in half in 2020, possibly of course due to the pandemic, so perhaps that interest coverage ratio is not as dangerous as it appears, you know a ratio of about 8.9.

If they’re able to double their net income back to what it used to be, that really would not be alarming at all. Alright, so this company has not been stable. I’m looking at their Dupont analysis, you can check out my video on this in the description below.

But essentially, I’m looking at return on equity and how that is composed of its three components. The return on equity has actually been negative in 2016. It’s been very low in 2017, really exploded there the past couple years before again dropping 20%, so I don’t like the volatility I’m seeing. Let’s have a look at the components of return on equity.

First thing to note is margins here, net income margin, how much profit do you generate for every dollar of sales for this company. I would like to say it’s 11 cents, but I really can’t say that. I mean they’ve been up and down, you know, coming in at 7.2% recently, so I really don’t love the volatility here, it’s gonna make my job hard as I try and forecast things for Caterpillar. Asset turnover tells us how much sales can you generate for every dollar of assets in place.

I like the direction it was going, of course, they took a hit during the pandemic, but that is one area that I do think will come right back and get to that roughly you know 0.7 there, 70 cents for every dollar of assets, pretty efficient.

Of course, they have high leverage, and that is one of the factors that’s really driving the higher return on equity, so I would say that Caterpillar naturally isn’t a very profitable company, if you look at their what I would call organic components of their return – net income margin, asset turnover, they’re just using leverage to drive it up.

Alright, so what we’re looking at here is dividends and buybacks in millions of dollars for Caterpillar. You can see in the blue they have a pretty good dividend record, although they have had to cut that dividend at times there.

In red we have share buybacks, and what iI see here is they’ve spent even more on share buybacks than they have on dividends, and probably spent more than they can afford to, and that’s probably where they had to borrow money, and increase their leverage.

So going forward, I really wouldn’t expect these types of buybacks to be continuing. An even better way to assess how likely it is they’re going to continue paying dividends or doing buybacks is to have a look at those payout ratios.

So in the blue I have the regular dividend payout ratio which is the dividend they pay divided by net income, and that has been pretty low in good years, as you saw their net income got cut in half, so it’s kind of like it looks pretty high right now at 58%, but I do expect their income to go up again, so I’m not too worried about them cutting that dividend right now.

What I do see in green though is really kind of unsustainable buybacks there, you know they have to set aside some money for reinvestments, even for a company like Caterpillar.

I know they’re not a super tech company, but they do need to make reinvestments if they’re to grow at all. And what I see here is that they’re spending quite a bit on share buybacks, and I would say that’s probably not likely to keep up.

Okay, so at this point in the video, I want to use an intrinsic valuation model to come up with the fair value for Caterpillar stock. Now they have a bit more of a volatile operating history, so I am going to use a few different scenarios and show you guys what the value would be under each scenario. We’re going to begin with a forecast of revenues as that is kind of the most primary input into the model when you want to figure out what the free cash flows are going to be.

After we forecast those revenues we can then dig down into what their profits are going to be off of the revenues, we can look at reinvestment needs, and we can come up with a stream of free cash flows to equity.

Okay, so let’s first have a look at what analysts are predicting for revenue. Okay, so what we see here is about 14 analysts predicting this coming year’s revenue, they predict it’s going to be about 46 billion dollars which means about 11% growth from last year. In the year after we have another 10% growth predicted, and then about 4.35%.

Let’s plug these numbers in and then we’re going to have to estimate the road for the remainder of the 10 year period.

Let’s just get started with that. Okay, so here’s my 10 year plan for Caterpillar. First of all, we have revenue growth predictions from analysts, and we have by the next three years, after that we kind of have to figure out our own path. We don’t have any information.

I’m generally a little more conservative, I’m going to assume growth kind of tapers off there, but I’ll also keep in mind that I am being conservative when I do this. That gives us a stream of revenue.

To get from revenue to net income, I’m going to have to calculate a net income margin, so how profitable or of a company is Caterpillar going to be? Well, I’m going to start out with the base case here of 7.2% margins, I know their margins have been as high as 11%, maybe 11.5%, but they have had some other years where they actually lost money, negative margins there, so on average I think this is probably the best guess I have here 7.2%, that gives us net income.

Now the one final step, because we are equity holders, we’re going to go from net income to cash flows, we need to use a reinvestment rate, we have subtract reinvestments.

Now looking at the company you saw they had some decent growth there, but yet they didn’t really do much reinvesting, most of their reinvestments are cap x, they don’t really do any acquisitions, so for me a lower reinvestment rate is fine. Given their higher growth during the early years, I’m going to use a higher reinvestment rate. For later years, of course, as the growth rate goes down, the reinvestment rate goes down.

And so that gives us a stream of free cash flows. Let’s figure out the fair value now. Alright, guys, so here is our stream of free cash flows to equity. I discount them back to present value using a 7.5% discount rate. Why so high for Caterpillar?

Well, you saw their volatile operating history, you see their balance sheet, you know even though they are a household name, I really can’t go with a lower discount rate than 7.5%. This gives us a total firm value of about 70 billion dollars.

And you can see the three components of that value: you’ve got the cash on hand, you got the free cash flows over the next 10 years, and you got that terminal value. That means that under this forecast Caterpillar would be worth about 129 dollars per share.

Let’s go back and look at the assumptions there, let’s make it a little more optimistic case. Alright, guys let’s be a little more optimistic, let’s say net income marigin can return to its prominence there, let’s go with about 11.3 percent for net income margin.

And maybe after five years if they keep growing like that, maybe with economies of scale will kick it up to 12%, and so let’s see what happens when we change that assumption. Alright guys, so if we modify the net income margin for a bit more optimistic scenario there, we’re left with a fair value of about 110 billion, or about 202 dollars per share, making Caterpillar actually a good deal or just a fair value right now.

Here is insider trading activity for Caterpillar. You can see a lot more people selling than buying in the past 12 months, in the past three months it’s a little more even, with 16 sales and 9 buys.

Now when we look at the number of shares involved, it’s a little bit of a different story here. You can see an overwhelming majority of insiders are selling in the most recent 12-month period, now that signals a little bit older, I like to focus more on the past three months.

But even with the past three months, you have more than twice as many shares sold as shares bought, it’s a bit of a negative signal. Alright, guys so here are my final thoughts on Caterpillar.

First thought is that they’re a little bit riskier than their brand name would suggest. I mean Caterpillar, right, it’s a household name everybody knows about it. But when you dig into the financial statements, what you find is the company that really hasn’t even been able to pay a stable dividend for the past 10 years, they’ve had their dividend cuts, they have a pretty rough balance sheet, if you ask me it’s really not in great shape.

And so you know I’m actually not that impressed with their business, I’m not that impressed with their ROE, and how it’s made up, you know it’s mostly driven by leverage, it doesn’t actually look like a company that I’m really thrilled to own.

Now that being said, it is a good enough business, I would definitely consider owning it if the numbers work out and it is a good deal. But when I do the fair value analysis, when I use the intrinsic valuation model, what I see is a company that you know is trading on fair value on a good day. When I look at the margins and I say okay we’re going to have pretty good estimates of those margins going forward, yeah it can be a fair value.

But when I plug in what I view is a little more realistic margins, it quickly becomes overvalued. So you know for me, I’m gonna pass on it. Let me know what you’re gonna do in the comments below.

Continue Reading
Advertisement 300x250
You may also like...

More in Review

To Top