On Tuesday I added Caterpillar (CAT) to my Best Ideas List on Real Money Pro as a short at $141.60. Here are five reasons why:
-- While a cyclically dependent CAT had a large beat on the top and bottom lines, I believe the rebound in profitability is more than priced into the shares now. CAT's relative strength index (RSI) is 77 today. Since 2006 this has been the third time that RSI exceeded 75. On the two previous occasions the shares fell dramatically from those overbought levels.
-- The large increase in CAT's incremental margins -- 51% in the latest quarter -- could be short-lived and further earnings beats relative to consensus may be difficult to achieve. (I would note that CAT said despite year-over-year sales growth of 35%, the year-to-date margins will not be achieved in the fourth quarter.)
-- The third quarter may be a high watermark for Caterpillar's margins in the face of higher planned expenditures (discussed in yesterday's conference call), higher input costs (particularly steel), a rising work force (CAT added 6,100 workers and 3,700 workers year over year and sequentially) and a growing competitive pricing backdrop (the company stated that near the end of third quarter product price gains became more difficult to achieve).
-- The company's divisions -- construction, resource and E&T (energy and transportation) -- may be now facing maximum rates of sales growth.
-- The ongoing government investigation of Caterpillar continues and could create headline risk.
My price target is $115, or 16 times estimated 2018 earnings per share of $7.25.
This commentary originally appeared on Real Money Pro at 8:07 a.m. on Oct. 25. Click here to learn about Doug Kass's Daily Diary and this dynamic market information service for active traders.
