Caterpillar Plunges on Fears of Global Infrastructure Bust

Posted by: Ben Steverman on October 22, 2008

Stocks like Caterpillar (CAT) are one reason (though just one of the many reasons) the stock market is having such a terrible week.

Caterpillar shares are trading at a four-year low, down 13.4% in just the last five trading sessions.

Part of this is to blame on a weak earnings report on Tuesday morning. But the market is looking ahead, and, when it comes to this maker of heavy equipment, investors are scared.

Over the past year, the slowdown in the U.S. housing market and the weak U.S. economy has hurt Caterpillar somewhat. But nonetheless the stock was celebrated by some investors for its role in the much-discussed “global infrastructure boom.” Sales abroad were brisk as Caterpillar equipment was used to help build roads, bridges, oil pipelines, skyscrapers, sewer systems in both the developed and developing world.

Much of this infrastructure build-out was fueled by high commodity prices. Places like Brazil, Russia and oil-rich Middle Eastern states had billions to invest on new infrastructure.

On Wednesday, the price of a barrel of crude dropped $4.80, or 6.65%, to $67.38. That’s less than half its peak earlier this year. Other commodity prices are also in the doldrums as a global economic slowdown saps demand.

For Caterpillar, this potentially knocks out the last leg propping up its business.

From the AP story on Caterpillar’s earnings report:

Jim Owens, Caterpillar’s chairman and chief executive, [said] demand in emerging markets and commodity prices that have encouraged investment in mining and energy had helped offset negative economic conditions in much of the developed world. He pointed to “recessionary conditions in North America and growing weakness in Europe and Japan.”

In other words, Caterpillar hasn’t even begun to feel the effects of a global emerging markets slowdown. If you’re an investor betting it will occur, you’ve probably already sold your Caterpillar stock.

Of course, lower commodity prices may actually help Caterpillar a bit because its raw material costs will fall. But that won’t help very much if Caterpillar sells less of its equipment.

Eli Lustgarten, a savvy analyst at Longbow Research, is seriously worried about an overall drop in demand for Caterpillar products. He wrote:

The key issue is whether the unfolding economic weakness extends into 2010, or whether a potential market upturn in developed countries occurs in time to offset any potential weakness in the large equipment demand if commodity prices/energy price weakness results in further postponement of capital projects in these areas.

I’m certainly not suggesting Caterpillar is in any serious financial trouble. This is a strong company with a solid balance sheet. But it is now clear that Caterpillar’s recent good times have come to a grinding halt.

Reader Comments

wtbird92

October 22, 2008 11:48 PM

Another problem they will encounter is the strong dollar.

Ben Steverman

October 23, 2008 10:04 AM

That's a very good point, Wtbird92. The strengthening dollar is a big worry for all U.S. manufacturers.

Ryan

October 23, 2008 10:22 AM

Ben, how can you seriously write that final sentence?

Cat will have EPS and Sales growth end 2008, way up from 2007. Yes, there are big headwinds, but the company has already come out with 2008 sales about even (including the ~$1B additive from Cat Japan integration).

Even if Cat lowers 2009 EPS projections to 5.50 (drop of 8%), that is still doing very well in light of other companies. North America has been down for Cat for three years, and the longer that market is down, the more violent the upswing is historically.

Cat at these prices are a steal, very smart investors will use this time to accumulate. At these historic trough times, Cat's P/E is usually 9-10, now it is 6 forward, if 2009 is 5.50. The secret is the first two years of an upswing, Cat's P/E swells to 20. So, if even $5.00 is the bottom, without any EPS growth and just cyclicality mutliple expansion, thath stock is sitting at $100.

This is a lapse, that's all. People who don't understand that will miss out on a lot of money. The secret in the infrastructure game is, the more you put in place, the more it has to be upgraded and replaced.

Ryan

October 23, 2008 10:31 AM

Wtbird92,

Stong dollar doesn't affect Cat like you'd think, unless its extremely strong. For 90% of Cat's products, they have local manufacturing in the three trispheres: Americas, EAME, and Asia-Pac. So, any weak dollar benefit is somewhat offset by the imported currency local cost basis.

The only thing it really affects are very large machines, which remain built mostly in Illinois.

Reno

October 23, 2008 10:50 AM

Weren't these yahoos busy buying back shares at tourist prices - like in the $80's and $70's, and $60's - and wasted billions and billions of hard-earned dollars? Hey, I've got a better idea: you would've been better off buying real estate at the top! The sheer stupidity and arrogance of management tells me that these yahoos are NOT to be trusted in any way, shape, or form. Stock goes to the teens from here.

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About

Bloomberg Businessweek’s Ben Steverman focuses on the latest moves in financial markets and emerging trends in stocks, bonds, and funds, always with an eye toward giving readers a better understanding of the sometimes confusing and often chaotic world of money. Standard & Poor’s senior index analyst Howard Silverblatt will also provide his take on companies’ finances and the markets. Voted one of the “Top 100 Finance Blogs” in 2007.

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