Tuesday, June 21, 2011

Will Caterpillar Help Build Your Net Worth?

Caterpillar (NYSE: CAT) dealers just reported that their May 2011 engine sales spiked 21% from the previous year. Can buying the stock of this world leader in construction equipment boost the value of your portfolio?

Caterpillar makes construction and mining equipment, diesel and natural gas engines, industrial gas turbines, and diesel-electric locomotives. It makes construction and mining machines, builds and sells the engines that power them, and finances and insures their purchase and operation.

And Caterpillar makes a hefty profit from all this. It generated $47.3 billion in revenues, up 32% in the last year and $3.7 billion in profit up 202% . Moreover, in so doing Caterpillar has built up a $63 billion market capitalization -- up 49% in the last year. The biggest financial risk for Caterpillar is its 2.34 debt to equity ratio -- far above the industry's 1.89.

Caterpillar's recent spike in engine sales is compelling -- but it masks a slowdown in growth over recent months and wide variations in growth by engine type. For example, Caterpillar's total engine demand grew faster in February 2011 (31%), March 2011 (45%), and April 2011 (25%).

Moreover, its 21% May 2011 growth by engine type indicates shrinking demand for some kinds of engines and rising demand for others. For example, sales were up for 45% for electric power, up 32% for industrial, and up 12% for petroleum and down 27% for marine engines. This suggests that a slowdown in emerging markets -- like China and India which use these engines for electric power and industrial applications -- would be bad for Caterpillar investors.

So far in 2011, Caterpillar's results have been tremendous. It first-quarter earnings of $1.23 billion, or $1.84 a share, were up 429% from $233 million, or 36 cents a share, a year earlier. Sales spiked 57% to $12.95 billion. Caterpillar raised its forecast for 2011 earnings, projecting profits would exceed its previous record set in 2008.

But Caterpillar is not earning enough to repay the providers of its capital. Although it's producing positive EVA Momentum, up 7% -- that represents an improvement over a bad 2009 while problems remained in 2010. That's because Caterpillar had negative EVA in both years -- ($3,952) million in 2009 and ($1,690) million in 2010 on 2009 revenues of $32.4 billion.

And Caterpillar's PEG of 0.57 makes it look seriously under-valued -- its P/E is 17.4 on earnings expected to climb 30.5% to $9.05 in 2012.

Caterpillar is a huge consumer of capital but if it keeps growing profits as quickly as it has recently, it should out-earn that cost of capital in the next year or two. If demand slows down in Asia though -- look out below.


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