Caterpillar (CAT, Financial) is one of the best stocks to talk about when it comes to sustained value creation in the past. I remain very positive on Caterpillar – as a company – for the long term. However, from a stock price perspective, I am bearish on the stock for 2015. This article discusses the reasons for the view.
The first reason and the widely discussed reason to be bearish on Caterpillar is China. The country’s economic growth is expected to remain weak in 2015 after sluggish economic activity in 2014. China’s industrial commodity industry has been one of the primary growth drivers for Caterpillar in the past. With the industry depressed, Caterpillar’s sales will be impacted even in 2015 when it comes to contribution from China.
The second reason to be bearish on Caterpillar is the big slump in oil prices. In 2014, Caterpillar’s lower revenue in China was offset by higher sales to the oil and gas industry in US, Middle East and Latin America. However, as oil prices trend below $50 per barrel and look to sustain at those levels, I expect Caterpillar’s business from the oil and gas industry to be impacted significantly in 2015.
The extent of impact still needs to be seen, and I believe that Caterpillar will come with a fresh guidance on revenue and EPS for 2015. I am concerned that 2015 revenue can be lower than 2014 as both the growth drivers for Caterpillar are likely to remain depressed in 2015.
In such a scenario, I expect no EPS growth and the current PE of 14.2 means that the PEG will be significantly higher. Caterpillar is trading at a five-year PEG of 1.29 and this indicates overvaluation considering the future growth potential. In particular, the growth outlook for 2015 will be depressed and this will take Caterpillar lower even when the stock offers a dividend payout of $2.8 per share.
I believe that the best time to buy Caterpillar will be when there is a bottom in place for oil prices. At this point, oil is making new lows every week, and the decline seems unabated. Once oil prices bottom out and oil companies adjust their investments accordingly, there will be clarity on the company’s revenue from the oil and gas segment.
For China, it is likely that the slowdown sustains through 2015. However, Caterpillar has discounted the China slowdown factor. I expect further decline due to China only if China’s growth in 2015 is worse than expected. IMF GDP forecast suggests that China is likely to grow at 7.1% in 2015. If growth slumps below these forecasted levels, investors can expect some more downside for Caterpillar.
Therefore, my conclusion is that Caterpillar has difficult times ahead and I am also sure that the company will see through this difficult phase. However, it might make sense to consider the stock few quarters down the line when the impact of lower oil prices on revenue and EPS for 2015 is clear. From a 3-5 year investment horizon, Caterpillar remains an excellent stock with a robust dividend yield.
