It was supposed to be easy from here. When President Biden signed the $1T bi-partisan Infrastructure Investment and Jobs Act into law in November 2021, one knew that there would be plenty of need for the kind of equipment that Caterpillar (CAT) sells and United Rentals (URI) rents.
Both stocks soared into early 2023. Both stocks were downgraded this weekend by the very highly rated (5 stars at TipRanks) Mircea Dobre of Robert W. Baird.
As a matter of fact, as credit conditions are expected to tighten resulting in reduced economic activity, and as the US continues to forge ahead without an agreed upon budget for the current fiscal year, Dobre, who expects to see a slowdown in non-residential construction in particular, has downgraded Caterpillar twice in less than two months.
Back in mid-January, Dobre reiterated his "outperform" rating on CAT, while increasing his target price from $242 to $290. A week later, Dobre maintained this view. About two weeks later, on February 13th, Dobre downgraded CAT from "outperform" to "neutral", taking his target price down to $230, which is below the $242 target price that he had prior to increasing that target in January.
I'm not done. There's more. This weekend just ended saw Dobre downgraded CAT for a second time in just about six weeks, from "neutral" to "underperform", while taking his target price all the way down to $185.
I follow this analyst. He is consistent and quite stable. He is not one to react impulsively and upgrade or downgrade his opinion of any given stock unless he really sees something. This slowdown he mentions? Don't take it lightly.
If you doubt Dobre's opinion here, you can choose to follow Michael Feniger of Bank of America. Feniger reiterated his "buy" rating on CAT last week with a $295 target price. Feniger is also highly rated (5 stars at TipRanks), but not quite as highly rated as is Dobre. This does give me food for thought and reason to pause. I had been considering initiating CAT on this recent dip. The stock closed Friday down 18.4% from its 2023 high, but had found recent support at its 200 day SMA.
Earnings
Caterpillar is set to report the firm's first quarter financial results in about a month. Readers may recall that in late January, the firm reported a sizable EPS miss on a revenue beat. The greater than expected hit to margins were not well received up and down Wall Street. Currently, Wall Street looks for the current quarter to show an adjusted EPS of $3.75 on revenue of $15.1B. The year ago comp was $2.88 on $13.59B, so we are talking about 30% earnings growth on 12% revenue growth.
This does not seem too scary, but admittedly, the range of professional expectations is rather broad for both these top and bottom line results. Does that imply a degree of uncertainty?
The Fundamentals
Going back to the end of the fourth quarter, Caterpillar produced free cash flow of $2.03B for the quarter and free cash flow of $5.167B for the full year, which would make Caterpillar a free cash flow beast. If it had not dished out $6.7B in returns to shareholders in the forms of both dividend payouts and share repurchases for the full year, creating a cash flow deficit once all was said and done.
Turning to the balance sheet, Caterpillar ended the quarter/year with a cash position of $6.042B and inventories of $16.27B. This put current assets at $43.785B. Current liabilities ended the year at $31.531B, leaving the firm with a healthy looking current ratio of 1.39. However, should the environment for sales become more difficult, putting doubt in the valuation of those inventories, the firm's quick ratio drops to 0.87, which is not the end of the world, but also not nearly as robust in appearance. The firm also has about $11.156B in current Finance Division debt included in these liabilities.
Total assets amounted to $81.943B. This includes $6.046B in goodwill and other intangibles. At 7% of total assets, this is not a problem. Total liabilities less equity came to $66.052B. This includes $9.442B in long-term debt and another $16.216B in non-current Finance Division debt.
If you know me, then you know that I think this firm would do well to increase its cash position versus its debt-load. How shareholders would receive that would not likely be with open arms, but the firm is going to have to be smarter and more defensive with its still large free cash flow.
The Chart
Readers will note that CAT has found support at its 200 day SMA (simple moving average), which also just happens to be the 50% retracement (half way back) level of the September through late January rally. Since then, the shares have come under some intense pressure to a greater degree than have the Industrials as a sector.
At this point, relative strength is weak, but not oversold, while the daily MACD (Moving Average Convergence Divergence) is depressed with all three components now moving below zero. Our Pitchfork model gives us an idea of where this stock might head should this downgrade weight upon the stock to the point where this support level either cracks or dissipates.
Is $190 possible as soon as April? I see no reason why not, especially if investors remain sour on the stock going into earnings and especially if the recently very poor macro economic data for February shows no signs of improving seasonally as winter ebbs.
Readers may also want to make note of that unfilled gap from late October. The stock needs to trade at $199 to fill that gap, which also happens to be a perfect 61.8% Fibonacci retracement of the above mentioned rally if it can get there. I think that's a far more likely landing spot than $190, for now.
Idea
My idea would be to buy nothing at the stock's current level. I think the sale of $190 May 5th looks interesting if one can get $3 to $3.50 for taking on that risk. If I were to make that sale, I would look to purchase a like amount of $180 May 5th puts for less than $2. This way, the trader protects him or herself from calamity, while still generating a net credit (in premium) of $1 to $1.50.
That said, I think that the $199 level that we just discussed might be the spot to enter with a small portion (I usually go with about 1/8) of one's intended full equity position size (in dollars, not shares).
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