Valuation: Undervalued

Will We See Caterpillar ($CAT) Bounce Post-Covid?

Analysts have forecasted that the Caterpillar stock price will rebound post-pandemic, and finally start to post favourable earnings releases. This is partially why people believe Caterpillar to be one of the best infrastructure stocks to buy in 2021.
- This helps investors to recognize and get exited for Caterpillar’s future.
Through several different valuation techniques, I arrived at a fair value price target of Caterpillar of $238/share, which implies an upside of 13% (at the time of creating this analysis).
- However, there are both risks and catalysts to this investment that may have an unexpected impact on the shares price, a list of these can be found at the end of this report.
- I think that Caterpillar could be one of the best dividend stocks right now and would be a good addition into any portfolio.
Caterpillar among other heavy machine manufacturers struggled during the pandemic due to financial and social conditions surrounding the Covid-19 pandemic. People were forced to stop operating/working, and others did not have the funds to make large purchases during the pandemic.
- However, this created a good buying opportunity for these value stocks, namely Caterpillar.
This report was created to provide due diligence to potential investors in value stocks such as Caterpillar.

Company Information:

$CAT - Caterpillar Inc. is the world’s leading manufacturer of construction and mining equipment, among other equipment and vehicles. Caterpillar operates under 4 main business segments, which consist of Construction Industries, Resource Industries, Energy & Transportation, and Financial Products.

Investment Information:

Business Reporting Segments:

Construction: This is Caterpillar’s largest business segment and provides their customers with the machinery necessary for construction, forestry, and building infrastructure. The demand for Caterpillar’s machinery is worldwide, however it varies depending on the business/companies’ circumstances. Caterpillar offers differentiated products for customers of different geographies, financial situations, and use cases. Caterpillar’s machine offerings for this segment include various types of excavators, loaders, telehandlers, tractors (just to name a few).
Resource Industries: This segment provides their customers with the machinery necessary in the mining, quarry, aggregates, and construction fields. Caterpillar provides machine for both surface operations as well as for underground operations. Caterpillar’s equipment aids in the process of extracting precious metals and resources from the earth. Caterpillar makes their machines in this segment to have low life-time costs, be highly productive, and very reliable to meet the demand from their diverse customer base. Caterpillar’s offerings in this segment include shovels, drills, tractors, vehicles, compactors, scrapers etc.
Energy and Transportation: Caterpillar provides their products to their customers in the energy and transportation industries. These include oil and gas, rail, industrial power generation and more. This segment requires Caterpillar to meet emission standards that are continuously changing and are situational depending on geographies. Caterpillar is always looking for ways to innovate their products to stay ahead of these changes. Caterpillar offers the following machinery for their customers in this segment, generators, reciprocating engines, turbines, compressors, diesel locomotives, and rail-related products.
Financial Products: Caterpillar delivers financial products to their customers through CAT Financial. CAT Financial provides their customers with financing options for their various product offerings. Some of their financial products include renting, financing, leasing, and loans. Having these options helps Caterpillar to maximize their revenues and customer base through allowing them to purchase their machinery by means other than cash. Furthermore, CAT Financial also earns interest on these purchases which can further aid their revenue growth.

Order Backlog:

Caterpillar has an order backlog that amounts to $14.2B in deferred revenues for the fiscal year ending December 2020. Of this $3.6B is expected to be expensed as an allowance for doubtful accounts. This means that Caterpillar is not expecting to realize this $3.6B as revenue. Talking this into account, Caterpillar has approximately $10.6B in deferred revenues, that they can start to realize as early as this year.

Financial Information:

Financial Performance (Good): In 2020, Caterpillar decreased their operating costs by 18%, and decreased their “other” expenses by 23%.
Financial Performance (Bad): In 2020, Caterpillar’s total revenue decreased by 22%. This is especially bad due to the fact that their revenues dropped by more than their operating costs, which means that their operating margin shrunk in 2020. Furthermore, Caterpillar’s profit decreased by 51% which is a pretty sizable amount and may scare off potential investors.
Common Shares Issues (Treasury Stock Compensation): In 2020, Caterpillar issued 5,317,243 common shares through the conversion of treasury shares (given out to employees as compensation). This issuance of shares had a dilutionary effect on the existing $CAT shares of 1% which is not very significant.
Common Share Repurchase: In 2020, Caterpillar repurchased 10,096,006 common shares as part of their share repurchase program. This share repurchasing increased the value of the existing $CAT shares by 2%.
Total Dilution: In 2020, Caterpillar ended up purchasing more shares back then they offered, which is a very good sign for investors. Overall, in 2020, Caterpillars existing shares rose in value by approximately 1% due to their buybacks.

Competition:

In order to undergo my comparable analysis (which is yet to be seen), I needed to find 4 companies that I could use to compare to Caterpillar that will assist me in valuing Caterpillar as a company.

These companies have to be publicly listed, operate in a similar manner, be of similar marker cap, operate in similar geographies, and have valid financial ratios and multiples.

By using the above criteria, I arrived with the following 4 comparable companies:

$DE Stock – Deere & Co: Deere & Co. manufactures and distributes equipment worldwide. Deere also operates in 4 main segments, which include Agriculture, Construction, Forestry, and Financial Services. They compete with Caterpillar in the Construction, and Forestry segments as their product offerings in these spaces are the most similar.

$PCAR Stock – Paccar Inc: Paccar Inc. Is a distributor of trucks and their parts. Paccar has 3 segments to their business Trucks, Parts, and Financial Services. Paccar offers their trucks to some companies that would use Caterpillar machines, so these companies are a bit more complimentary rather than competitive. However, I decided to include Paccar because they have the same target market and they both manufacture vehicles and provide financial services for their end customers.

$TEX Stock – Terex Corp: Terex provides both Aerial Work Platforms, and Materials Processing machinery. Their Aerial platform products include lifts, articulating booms, telescopic booms, telehandlers, and utility equipment. Terex is more of a competitor in the construction space, as they provide machinery that is commonly used on construction sites.

$OSK Stock – Oshkosh Corp: Oshkosh manufactures and markets their specialty vehicle worldwide. Oshkosh provides machines such as telehandlers, wreckers, mixers, cranes among other vehicle and machine offerings. Oshkosh competes with Caterpillar in the mining, railroad, and construction industries.

Valuation Information:

WACC:

I was able to calculate my own high and low estimates of Caterpillar’s WACC through my models in the DCF model. The low WACC implies an equity/debt weighting of 80% and 20% respectively, and the high WACC implies a equity/debt weighting of 70% and 30% respectively. I then took the average of these two estimates to come to one final WACC estimate of 7.17%.

CAGR (2021-2023):

I used the average growth rate in the average analyst revenue growth forecasts for 2022 and 2023. The average growth rate that analysts are forecasting in this year is around 11.5%. I used this estimate because I believe it to be reasonable, contingent on the fact that Caterpillar can bounce back after the pandemic.

CAGR (2027-2030):

I estimated Caterpillar’s CAGR for 2027-2030 to be 4.6%. This is because this was their average Gross Profit CAGR, over the past 5 years (when factoring out the effects of covid). I think that Caterpillar will return to this level of steady growth after they bounce back from covid.

Other CAGR:

In the years between 2023-2027, I gradually decreased Caterpillar’s growth rate so there was a smooth transition into their 4.6% growth rate through 2030. In these years I decreased the average growth by 1.5% each year until 2027.

Operating Expense Increase Rate:

Over the past couple of years Caterpillars operating expenses have risen by an average of 1.94%. I used this growth rate to forecast their future operating expenses.

Interest Expense Increase Rate:

Over the past couple of years, Caterpillar’s interest expense has grown by an average of 5.64%, which I used to forecast their future increases in interest expense.

Depreciation and Amortization Increase Rate:

Over the past couple of years, Caterpillars Depreciation and Amortization figures have grown by a yearly average of 4.39%. I used this increase rate to forecast their future depreciation and amortization expenses.

Tax Rate:

I was able to locate Caterpillar’s annual effective tax rate for the year ending December 2020. I found this in their SEC 10-K filing, which was 25.2%.

Capital Expenditures (CAPEX) Decrease Rate:

Over the past couple of years, Caterpillar’s capital expenditures declined by an average rate of 7.8%. I used this decline rate to forecast the future decrease in Caterpillar’s capital expenditure figures.

Risk Free Rate:

I was able to find Caterpillar’s risk-free rate through Finbox, which estimated it to be 2.25%.

Investment Valuation:

DCF:

In order to properly value Caterpillar, I underwent a DCF model. In order to conduct this model, I used the information found above in the “valuation information” section of this report. By using this information, I arrived at a fair value of Caterpillar of $210/share, which implies that Caterpillar is currently at fair value. In order to gain more insight into the valuation of Caterpillar, I decided to undergo some comparable analyses.

Comparable Analyses:

EV/EBITDA:

By comparing Caterpillar’s EV/EBITDA multiple to that of their competitors (listed above in the “competition” section of this report), I found Caterpillar to have a fair value of $225/share, which implies an upside of 7%.

EV/Revenue:

By comparing Caterpillar’s EV/Revenue multiple to that of their competitors, I found Caterpillar to have a fair value of $146/share, which implies a downside risk of 30%. This is obviously very different from the valuation as achieved through their EV/EBITDA comparable, so I decided to do one more comparable to gain more insight.

P/E:

The last and final ratio that I compared was the P/E ratio, by doing this I found Caterpillar’s fair value to be $200, which implies a downside risk of 5%. All of the comparable analyses show drastically different valuations, and as a result of this I decided to take the average result to achieve one final comparable valuation.

Average Comparable:

By taking the average result as achieved through the 3 comparable analyses, I arrived at one final comparable valuation of $190/share. This valuation implies that there is a downside risk of an investment into Caterpillar of 9%.

Dividend Discount:

My last valuation estimate came from my dividend discount model. This model predicted that Caterpillar has a fair value of $312/share, which implies a 49% upside.

Plan:

In order to formulate a plan on investing into Caterpillar, I first decided to take the average result from the 3 different models that I created. By doing this I arrived at one final fair value of Caterpillar of $238/share, which implies an upside of 13%.

My plan for this investment would encompass buying under $210, which is the fair value achieved through the DCF model. After this, I would look to exit at $238/share, which is the final fair value that I achieved for the company as a whole. This plan would yield a 13% return if followed directly.

Risks:

Financial Performance: In 2020, Caterpillar had an overall poor financial performance. This financial performance worried investors, as well as myself for the future of this company. This performance can be attributed to covid, and many analysts are forecasting a bounce back. However, if this bounce back doesn’t come, or is not as big as anticipated, some investors may start to panic sell and hurt the share price.

Catalysts:

Financial Performance: As we know, there are many analysts that are forecasting Caterpillar to rebound after their poor financial performance this year. If Caterpillar is able to meet or even exceed these expectations, it will help their share price greatly, and instill investor confidence for a brighter future ahead.
Share Repurchases: In 2020, Caterpillar was able to repurchase over 10 million of their common shares. This big repurchase assisted in Caterpillar being able to achieve a lower shares outstanding balance over the year. This means that the existing shares increased value as a result, which is good to see or experience as an investor. If they announce that they are repurchasing more shares this year we should see a reflection of this in their stock price.