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Caterpillar Looks Positive Despite Tax Probe

Zacks Equity Research

Caterpillar Inc.’s (CAT) shares hit a 52-week high of $102.76 during intraday trading on Apr 2, buoyed by a report that the U.S private jobs have picked up and China’s mini stimulus will rev up its economy. The stock finally closed at $102.63, gaining almost 3% in a day. The closing share price reflects a year-to-date return of about 13.7%, outperforming the S&P return of 2.8%.

Caterpillar has emerged strong amid an ongoing Senate probe for possible overseas tax evasions. It is alleged that the company evaded around $2.4 billion of U.S. taxes by shifting profits to a wholly owned Swiss subsidiary. Caterpillar officials defended their case saying that the Swiss subsidiary was a real business and not a tax shelter as alleged. A similar movement was seen in shares of General Motors Company (GM) which gained 1.7% yesterday, despite facing congressional hearing as to why the automaker delayed recall of vehicles with faulty ignition switches. Investors’ confidence that the companies will not face severe consequences, is giving support to the shares.

Overall, the market got a lift following an employment report from ADP  that stated that 191,000 private sector jobs were added in March. Even though it came in a tad lower than analysts’ expectation of 195,000 jobs, it signals that the softness earlier this year was due to inclement weather and not economic weakness, thereby improving the market sentiment. Furthermore, China’s steps to steady its faltering economy by increasing expenditure on railways, upgrading housing for low-income households and tax relief for struggling small businesses. Investment in infrastructure bodes well for companies like Caterpillar which has a wide exposure to China.

Caterpillar is currently trading at a forward P/E of 17.5x, at a 3.7% discount to the peer group average of 18.17x. Caterpillar’s ROE of 20.2% is higher than the peer average of 18.7%. The last traded price is 4.8% above the Zacks Consensus average analyst price target of $102.63. Average volume of shares traded over the last 3 months is approximately 6,360K. Caterpillar has long-term estimated earnings per share growth rate of 8.5%.

Shares of this company, with a market cap of $65.5 billion, have gained momentum since reporting its fourth-quarter earnings on Jan 27. Prices held up steadily above $90 and crossed the $100 milestone on Mar 31, the level last reached in May 2012. Despite a 10% decline in revenues to $14.4 billion, Caterpillar delivered a 48% rise in its earnings to $1.54 per share, helped by its aggressive cost cutting actions. Following three straight quarters of decline in earnings in 2013, Caterpillar finally turned the tables in the fourth quarter with a year-over-year earnings improvement and broke the jinx of four consecutive negative earnings surprises.

Caterpillar will continue to benefit from its additional restructuring actions in 2014 to optimize its cost structure and improve the efficiency of operations. This will help mitigate the effect of lower mining-related sales on its profits. Caterpillar will also benefit from an increased share in the Chinese excavator market. Recovery in the U.S. construction sector and stabilization in Europe add to the growth story.

With Caterpillar shares trading at a 52-week high, there is further scope of an uptrend, as suggested by the company's Zacks Rank #2 (Buy). Other players in the machinery industry, which look attractive at current levels, include Komatsu Ltd. (KMTUY) and  Manitowoc Company, Inc. (MTW)  both sporting a Zacks Rank #1 (Strong Buy).

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