This CAT Can Continue to Purr Happily

 | May 30, 2017 | 11:00 AM EDT
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In an article published on Feb. 1, I said I thought shares of Caterpillar (CAT) had priced in a lot of good news. Since then, the stock is up about 11% on optimism the heavy equipment business is finally turning around.

On April 25, CAT reported first-quarter fiscal 2017 earnings of $1.28, $0.65 better than the consensus estimate. Excluding restructuring costs, revenue rose 3.8% to $9.82 billion.

The better-than-expected results were due to higher sales volumes from better end-user demand in the resources and mining industries. Sales volume in the energy and transportation segment increased slightly and sales to the construction industry were flat.

Higher equipment sales in China drove the international segment, while firmer commodity prices caused demand to increase in Australia. Sales in Latin America jumped 14%, mostly due to stabilizing economies.

Importantly, management increased fiscal 2017 guidance. The company sees earnings of $3.75 vs. the previous guidance of $3.26 per share. Management also increased the mid-point of their revenue estimate by $2 billion to $39.5 billion.

Caterpillar said its restructuring program is going better than expected, although it raised its outlook for the expected costs. The company expects to incur about $1.25 billion of restructuring costs vs. a previous estimate of $500 million back in January. Caterpillar is in the middle of a multi-year, multi-billion restructuring program designed to wring out costs and make higher profits on fewer shipments.

While Caterpillar's results were certainly better than expected, two things really lit a fire under the shares. First, Deere (DE) beat its quarterly estimates and gave an upbeat outlook. And second, sell-side surveys of Caterpillar dealers indicate firming demand and rising backlog.

Deere said it saw strong trends across all end markets and regions. The construction and Forestry segments sales were up 7% as a result of higher shipment volumes and higher price realizations. Deere said it expects 1.25 million housing starts in 2017, and that should drive equipment demand further.

The sell side spends a great deal of time surveying machinery dealers, and many firms are coming to the same conclusion: equipment sales are firming up across the board. Dealers are becoming more optimistic and less concerned about a mountain of used equipment on the market. In addition, dealers are seeing improved demand for spare parts, which indicates new machine orders could be on the horizon. Dealers also cite aging equipment out in the field as another reason for their growing optimism.

Merrill Lynch upgraded Caterpillar and Stifel raised their price target on Deere.

With the move in the stock, it is pretty evident investors have anticipated a massive turnaround in Caterpillar's business. In 2012, the company had revenue of $65.8 billion and EPS of $8.48. Even with a global business rebound, a return to those glory days looks a long way away.

From its 52-week low, shares of Caterpillar are up 50%. Year to date, the stock is up nearly 14%. Analysts are now forecasting earnings of $4.07 per share for fiscal 2017 and $5.18 for next year. Likewise, revenue is expected to be up 4.3% to $40.2 billion this year and up 5.2% to $42.3 billion. These forecasts are a big change from February, when analysts were thinking $4 per share was a 2019 phenomenon and Caterpillar would be lucky to put up flat "growth".

Historically, Caterpillar trades between 18x and 24x forward estimates. Assuming CAT is in recovery mode, I think the stock can continue to climb. Using a 24x multiple on next year's estimates, I can see the stock moving towards $125 by this time next year. I think this CAT can continue to purr.

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