Ride the Global Construction Boom With Caterpillar
Caterpillar rallied in early August as the Senate passed a bipartisan infrastructure bill.
Aug. 20, 2021 7:00 am ET
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Despite being a major beneficiary of several emerging global trends,
isn’t a very well loved stock on Wall Street at the moment. That makes for an opportunity.
A few days of trading action over the summer capture the debate over the maker of excavators, construction and mining equipment and other heavy machinery. The stock fell 3.5% over two days after the company reported solid earnings on July 30 but also warned of sequentially lower margins in the third quarter. It then rallied 6.1% in early August as the Senate passed a bipartisan infrastructure bill with $550 billion of new spending over 10 years.
“Caterpillar is experiencing a cyclical recovery and that’s a positive, but there are a number of factors that are complicating that recovery,” says UBS analyst
“It’s somewhat different from a typical cycle.”
These near-term issues include supply-chain constraints and raw-materials shortages of the kind faced by many manufacturers. But the bigger picture is that much of the developed world appears poised to embark on a multiyear construction binge, led by both the public and private sectors. In Europe and the U.S., the baton of policy leadership has been passed from monetary to fiscal policy.
Emboldened by ultralow interest rates and the need to begin addressing climate change, leaders in these countries are beginning to think big again on infrastructure, energy and other public works. Meanwhile, in the private sector, housing shortages and the re-onshoring of certain manufacturing industries is likely to drive its own investment cycle, again enabled by low rates.
This should benefit Caterpillar handsomely once it gets over its near-term supply kinks, both in terms of direct construction activity and demand for raw materials such as copper, which its machines help mine. UBS estimates that every $100 billion of incremental construction spending in the U.S. could add 60 cents to Caterpillar’s earnings per share. (The company earned $5.46 a share in 2020.)
In a statement, Caterpillar Chief Executive
said the company welcomes the Senate passage of the infrastructure bill, adding that “infrastructure investment is a positive for our customers and for us.” That spending is certainly priced in. But other plans on the drawing board might not be, especially for a business as global as Caterpillar’s.
In the U.K. alone, for instance, Prime Minister
Conservative government has called for £600 billion of infrastructure investment, equivalent to $818 billion, over five years. The EU is loosening its purse strings with a €750 billion recovery package, equivalent to $875 billion, financed by common EU bonds. In spendthrift Germany, the newly popular Green Party, which could form part of a coalition government after elections in September, is calling for €50 billion a year of “green investments.”
President Biden’s infrastructure plan calls for non-traditional projects like the removal of some highways. What Democrats want for cities like Baltimore says a lot about the President’s goals in the next wave of development. Photo: Carlos Waters/WSJ
Back in the U.S., aside from the bipartisan infrastructure package, Democrats are planning an even bigger follow-on spending bill that would include incentives for renewable-energy generation. State governments are flush with cash and likely to embark on robust highway-building programs of their own, notes Stifel analyst Stanley Elliott.
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The one major exception to this rosy global picture is China, where authorities are currently cracking down on debt-financed investment and the frothy property market. But the truth is that a global construction and resource cycle less dominated by China, which is prone to frequent booms and busts on the whims of policy makers, would be a very healthy long-term development for Caterpillar.
Held back by China and supply-chain fears, Caterpillar is up just 12.3% so far this year, still underperforming the S&P 500’s 17.3%. Out of 26 analysts that cover the stock, just 11 rate it a buy, according to FactSet. The stock has historically traded in a wide valuation band of anywhere from 10 to 30 times forward earnings, so its current multiple of around 18 times doesn’t look unreasonable given its strong prospects.
Many things are uncertain as the world lurches through an uneven recovery from the pandemic, but strong demand for Caterpillar’s machines seems a near lock.
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Appeared in the August 21, 2021, print edition as ‘Investors Should Remain Hungry for Caterpillar.’