Caterpillar’s stock (CAT) has recently underperformed compared to the broader market, with declining revenues potentially causing some investor unease. However, I believe there is little reason for concern regarding this global heavyweight in heavy machinery and construction. The slight revenue dip follows a significant growth period, reflecting a natural normalization. Meanwhile, the company is still on track to achieve record earnings this year, reinforcing the strength of its investment case. Thus, I remain bullish on the stock and confident in its long-term potential.
Contextualizing Caterpillar’s Revenue Decline
To examine the bullish narrative, we first need to contextualize Caterpillar’s second-quarter results. CAT Q2 results were marked by a 3.5% decline in revenue, which may have unsettled some investors. However, I think this decrease appears relatively negligible when viewed in the proper context. After a tough 2020, where demand for industrial machinery plummeted due to the COVID-19 pandemic, Caterpillar experienced three consecutive years of superb growth, primarily driven by the Infrastructure Investment and Jobs Act, which began in 2021 and continues to unfold.
Therefore, the machinery giant’s revenues surged by 22.1% in 2021, 16.6% in 2022, and 12.8% in 2023. Due to such a prolonged period of outsized growth, a modest decline as dealer inventories stabilize is natural and expected.
Specifically, during the previous three years, dealer inventories were built up notably in anticipation of sustained demand and potential supply chain disruptions. With the market beginning to stabilize and supply chain issues easing, dealers are now working through these elevated inventory levels, resulting in reduced new equipment orders from Caterpillar.
This normalization in dealer inventories is a logical response to the inflated levels seen in recent years. For this reason, I don’t think it should be interpreted as an alarming sign for medium-term prospects.
Caterpillar’s Margins Shine
Another notable factor that should overshadow Caterpillar’s modest revenue decline is its impressive profit margin improvement. The company’s focus on achieving internal efficiencies, controlling costs, and implementing smart pricing has driven margin expansion, even with lower sales. If you follow industrial stocks, then you know this is a rare occurrence and a very impressive feat to pull off.
If I’m being more specific, Caterpillar’s adjusted operating profit margin for the quarter rose to 22.4%, up from 21.3% in the previous year. This resulted in an adjusted earnings per share (EPS) of $5.99, marking an 8% increase from last year’s $5.55.
While forecasts predict a continued revenue decline in Q3 and Q4, analysts expect positive margin and earnings trends to persist. Thus, while full-year revenues may be slightly lower than last year, adjusted EPS is projected to grow by about 4%, reaching a record $22.06, according to Wall Street estimates.
Caterpillar’s Attractive Valuation
With Caterpillar’s share price underperforming lately despite projections for record EPS this year, its valuation seems to have approached rather attractive levels. In fact, I think that Caterpillar’s current valuation presents a promising opportunity for upside potential, further enhancing the bullish narrative.
As mentioned earlier, Wall Street expects adjusted EPS of $22.06 for the year, translating to a P/E ratio of 15.6 at today’s price levels. While Caterpillar is influenced by cyclical factors that may justify a prudent multiple, I think the ongoing boost from raised government infrastructure spending is expected to drive stable growth in the coming years.
Consensus estimates anticipate mid-single-digit growth over the medium term and coupled with Caterpillar’s strong market position and overall attributes, this could reignite bullish sentiment for the stock.
Is CAT Stock a Buy, According to Analysts?
Wall Street’s perspective on Caterpillar appears to be more cautious than mine. CAT stock has a Hold consensus rating, reflecting a combination of three Buy, six Hold, and one Sell recommendations over the past three months. With an average price target of $341.38, analysts suggest there may be no anticipated upside from the stock’s current price levels.
If you’re uncertain which analyst to follow for trading CAT stock, Jamie Cook from Truist Financial stands out as the most accurate choice over the past year. With an average return of 28.81% per rating and a success rate of 84%, Cook’s insights could be highly valuable. Click on the image below to learn more.
Takeaway
Despite Q2’s revenue dip, Caterpillar’s investment case remains quite compelling. The modest decline in sales following years of outsized growth reflects a natural market correction rather than a fundamental issue. In the meantime, the company’s expanding profit margins and anticipated record EPS for the year underscore its operating excellence.
Accordingly, following the stock’s lag in recent months, I believe that CAT stock offers an attractive buying opportunity at its current levels. With single-digit revenues and earnings growth expected to endure over the medium term and a reasonable valuation multiple in the mid-teens, CAT stock will likely see renewed investor interest moving forward. Therefore, I am bullish on CAT stock prospects.
