Caterpillar (CAT) shares have had a terrible go of it in 2015, falling from 105 in December to just 65 today. Shares dropped more than 6% Thursday on a disappointing corporate update from Caterpillar.
The company cut its revenue guidance for both this year and next, citing difficulties in its various operating segments. The company announced up to 10,000 layoffs coming by 2020. In all, it was a very negative report, showing the global slowdown has hit the company harder than analysts had speculated.
With Thursday’s drop, Caterpillar has fallen below the 2011 European panic lows, and now trades back where it did five years ago.
For many companies, that would be a great indicator of value 5 year lows for a giant global behemoth. In Caterpillar’s case, a 5-year low isn’t necessarily a sign of great value. Its industry, construction, is ruthlessly cyclical, going from bust to boom and back to utter despair frequently.
Caterpillar shares shot up between 2009 and 2011 as the global economy exited the financial crisis, metals prices soared, and the global emerging market started to demand more and more equipment with which to build vast amounts of infrastructure.
Gold prices peaked in mid-2011, and with that, one of the pillars of the Caterpillar boom was toppled. The meteoric rise in the precious metal mining industry came turned to a bust. The gold mining industry, as represented by the GDX ETF is down more than 80% from its peak, and mining industry capital expenditures have been slashed to the bone. Result: Far fewer Caterpillar sales.
Other mining sectors took longer to cave-in, but they’ve pretty much all given way now. Copper started to drop hard last year. The coal industry has collapsed, buried by heavy regulations from the current administration. And now the iron ore price has yielded under the weight of the slowing global economy.
Caterpillar also sells lots of equipment into the oil and natural gas extraction industry. Naturally, these sales have slowed dramatically since last fall when the price of oil began to implode.
Some segments have held up better. Homebuilding is fairly strong in many areas of the world, particularly in the United States, and as such, sales in the construction sector have remained stable.
But overall, it’s been a dark year for Caterpillar. Revenues are dropping, and earnings are slipping with them. Adding insult to injury, the company’s highest-margin products are in the oil & gas space which has been hit hardest in 2015.
Another problem comes with the strength of the US dollar, which is making the company’s products more expensive versus foreign competition, in particular the Japanese firm Komatsu. Falling sales combined with increased competition isn’t a good mix.
So, if there’s so many negatives, then why is this the time to buy Caterpillar? Good question. Remember, first and foremost, that Caterpillar is a hyper-cyclical stock that is supposed to behave exactly like this. The stock soars in good times and plunges in bad ones; this action is precisely why we have an opportunity now.
At the current $65 share price, the company yields a mouth-watering 4.7%. For a storied mega-cap corporation, that’s a great dividend.
And the company is aggressively buying back shares. With the company reducing the outstanding share count at very favorable prices, it adds dramatic earning power to Caterpillar’s shares on the next upturn.
The company has a very strong balance sheet and a solid A credit rating. It is built to withstand these sorts of downturns. Buyers today get paid nearly 5% a year to wait for the cyclical upturn, all the while, the company is buying back shares rapidly.
Caterpillar shareholders who bought in the 2001 doldrums would make 400% on their money by 2007. Anyone who bought the 2009 low saw their shares go from $25 to $110 in under 2 years.
Given that the global economy has grown substantially since Caterpillar’s last peak in 2011 and that Caterpillar is reducing its share count smartly, it will be easy for Caterpillar to surpass the 2011 high and reach $120 or $130 on the next cyclical upturn, doubling a current investment.
There’s no guarantee that $65 is the bottom, cyclical stocks can go lower than you’d expect, but five years from now, it’s almost certain shares will be much higher than here.
