SNYYF - Caterpillar: It May Be Time To Cash Out

Summary

• Despite the rapid reopening cadence in China, things do not look as promising for CAT due to the intensely competitive Chinese-made construction machinery.
• Chinese-made excavators had seen immense growth in global demand by 59.8% YoY in 2022, compared to CAT's 16.5% revenue growth at the same time.
• CAT appeared to lag in the introduction of electric construction machinery as well, potentially triggering more headwinds in its forward execution.
• Combined with the 55.3% surge from the September 2022 bottom and the weaker FQ1'23 guidance, the CAT stock may have peaked.
• Investors would be well advised to take some gains off the table since the stellar dividends may not compensate for the possible plunges at the first hint of pessimism.

The China Reopening May Not Contribute To CAT's Top & Bottom Line Growth

While we have been upbeat about China's rapid reopening cadence with regard to iron ore, dry bulk shipping rates , lithium , and discretionary spending , amongst others, things do not look as promising for Caterpillar (CAT).

CAT's financial report did not break down its revenues by specific countries. However, the Asian Pacific region comprised $11.89B, or the equivalent of 20% of its sales in FY2022. Notably, the management had previously highlighted that China's demand constituted up to 10% of its annual enterprise sales .

The COVID-19 pandemic naturally upended those numbers, with many consumers turning to Chinese-made construction machinery, while CAT struggled with supply chain disruptions for the first three quarters of 2022. However, things have improved tremendously by Q4'22, with the company achieving stronger-than-expected shipments. James Umpleby, CEO of CAT, said:

We achieved double-digit top-line increases in each of our three primary segments and saw sales growth in North America, Latin America, and the EAME, while Asia Pacific was about flat. ( Seeking Alpha )

For the whole of 2022, China's major excavator manufacturers exported 109.5K units , indicating a tremendous increase of 59.8% YoY. Notably, SANY Heavy Industry (SNYYF) reported 25.88B Yuan or the equivalent of $3.83B (based on the exchange rate at the time of writing) of international revenues for the first three quarters of 2022, growing by 43.7% YoY.

Although these numbers still paled in comparison to CAT's total revenues of $42.81B in the first three quarters of 2022 ($59.41B for 2022), the comparably slower YoY growth of 15.2% (16.5% for 2022) was alarming indeed.

The situation was especially worsened by the global market share gain by SNYYF in the excavator segment to 8% in 2022, at the expense of CAT's decline in the construction machinery segment, from 15% in 2020 to 13% in 2022 . This might be partly attributed to SNYYF's record 60% growth in key markets such as the US, the UK, Brazil, and Canada as well.

The downtrend might also be partly attributed to the recent push for electric construction vehicles for mining purposes in South America, a region comprising $6.73B or the equivalent of 11.3% of CAT's sales in 2022.

As it turned out, CAT had been slightly lagging in the electric end-market, with SNYYF already delivering 23 units of 60 Tonnes electric trucks to CSN Mineração, the mining arm of Brazilian steelmaker Companhia Siderúrgica Nacional (SID), by mid-2022. The equipment's excellent performance led to further orders of nine electric trucks to CSN Cimentos, the company's cement subsidiary by the end of 2022.

Notably, SNYYF unveiled its first 1.6 Tonnes electric mini-excavator in November 2020, with its first 300 Tonnes class electric-drive hydraulic front shovel by January 2022. Adalberto Maluf, president of ABVE, said:

China created a public policy to dominate the entire chain linked to the production of electric vehicles and batteries. Due to this, Chinese industry has become extremely competitive and is coming out on top in the supply of electrical equipment for various sectors. ( Bnamericas )

Now, why did we say that CAT was lagging in this sector? It was because the company only introduced four of its electric machine prototypes , including the mini/ medium excavators and compact/ medium wheel loaders in October 2022, with only the smaller excavators and wheel loaders available commercially. It also presented its first battery electric mining truck as a prototype in November 2022, with no confirmed launch date, albeit at a remarkably competitive capacity of 360 Tonnes .

While China's first-mover advantage in electric construction machinery may not win the race, CAT's declining market share globally is worrying indeed, especially since demand from China is expected to remain below 2022 levels .

CAT's Backbone Remains In North America

On the other hand, CAT's order backlog grew impressively to $30.4B by FQ4'22, increasing by 1.3% QoQ from $30B and 31.6% YoY from $23.1B . These suggest the strength of its long-term market demand and the easing of global supply chain issues.

Notably, North America comprised 47.2% of CAT's revenues in the last fiscal year, with more contribution expected from the $1.2T Infrastructure Bill spread over the next decade . Therefore, investors likely need not fret about the company's elevated inventory levels of $17.56B in FQ4'22, growing by 25.1% YoY from $14.03B, or 55.9% from FQ4'19 levels of $11.26B.

For now, market analysts are bullishly projecting CAT dividends of $5.25 by FY2024, suggesting a forward yield of 2.08% against its 4Y average of 2.45% and sector median of 1.68%. This further underscored the excellent shareholder returns over the past few years, with the management returning $2.41B in dividends (+3.7% YoY) while repurchasing $4.35B of shares (+63.2% YoY) in 2022.

It is evident that the focus on long-term growth took precedence now, which explained CAT's minimal deleveraging thus far, with Machinery, Energy & Transportation long-term debts of $9.61B (-0.5% YoY) in FQ4'22, with declining cash/ investments of $7B (-25.4% YoY).

We reckon this strategy may prove prudent in the intermediate term, since CAT is expected to expand its profit margins from adj. EBIT/ net income/ FCF margins of 15.4%/11.7%/9% in FY2019 to 16.4%/13%/15.1% by FY2024. These may consequently trigger an expanded top and bottom-line growth at a projected CAGR of 7.9% and 15.6% through FY2024, against the pandemic levels of 2.9% and 8.0%, respectively.

So, Is CAT Stock A Buy , Sell, or Hold?

CAT 1Y P/E Valuations

CAT is currently trading at a NTM P/E of 15.69x, lower than its 3Y pre-pandemic mean of 16.48x, otherwise, relatively in line with its 1Y mean of 15.60x.

Based on its projected FY2023 EPS of $15.24 and current P/E valuations, we are looking at a moderate price target of $239.11, nearing the consensus estimates of $251.73 as well.

CAT 1Y Stock Price

It is apparent that most of the optimism is already baked in, offering no margin of safety for those looking to add here, significantly exacerbated by the 55.3% surge from the September 2022 bottom. In addition, the stock appeared to have broken through its previous November/ December resistance levels and recorded an excellent 6.5% rally over the past few weeks.

While we remain confident about CAT's fundamental performance in North America, investors need to proceed with caution in the short term. As with most industrial/cyclical stocks, portfolios should also be sized appropriately since the stellar dividends may not cover the potential plunge in share price, especially when it is unknown when the stock may peak.

Combined with the CAT management's forward commentary on seasonal weaknesses in FQ1'23, with forecasts for adj. EPS of ~$4 against consensus estimates of $4.5, we may see the stock underperform from these levels. As a result, conservative investors looking to preserve some gains may consider selling part of their holdings then, while getting in at the $210s, if not lower. Do not chase this stock.

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