CAT - Caterpillar To Benefit From The Infrastructure Deal And Rising Oil And Gas Capex

2023-03-08 10:59:20 ET

Summary

• Machinery sales surged by 21% YoY in Q4, showing the company finished the year strong.
• CAT has opportunities for growth due to the Bipartisan Infrastructure Deal and the expected increase in oil and gas capex, which can offset the stagnation in mining.
• Based on these factors, the shares of CAT appear to be fairly priced.

Caterpillar Inc. ( CAT ) has a robust competitive advantage thanks to its reliable brand, broad dealer network, and superior products tailored to meet individual customer requirements. With the US Infrastructure deal and the resurgence of investments in oil and gas, I believe CAT will benefit, which will counterbalance the stagnation in the mining sector. In this article, I will summarize the Q4 results, provide a more detailed analysis of the outlook for each of the three segments, and conclude with the valuation. Based on my assessment, I believe the shares are fairly priced.

The Company

CAT stock is a top-tier manufacturer of heavy equipment, power solutions, and locomotives. CAT is recognized as the largest heavy equipment manufacturer in the world, holding a market share of over 13% in 2021 . CAT operates in four main segments, namely construction industries, resource industries, energy and transportation, and CAT Financial Services. Its extensive dealer network spans the globe, comprising 160 dealers and about 2,700 branches, ensuring its products' availability to customers worldwide. CAT Financial Services provides retail financing options for machinery and engines and wholesale financing for dealers, ultimately boosting CAT's sales.

Q4 Results

On January 31, CAT released its Q4 and full-year results. CAT finished off 2022 on a strong note, reporting impressive fourth-quarter results. CAT's machinery sales surged 21% YoY to reach $15.8 billion, driven by higher sales volume and stronger pricing. Globally, retail sales to end-users rose by 4% YoY, with North America leading the growth at 13% YoY.

CAT's ability to meet end-user demand improved sequentially in Q4 2022 compared to Q3. CAT also noted that dealer inventories increased by $700 million sequentially in Q4 2022, providing an $800 million favorable impact on total sales compared to a year ago.

CAT's management provided adjusted profit margin guidance for various revenue scenarios for 2023.

A Lighter Company Than in 2015

CAT's strategy has been to reduce structural costs and its fixed asset base through cost management initiatives and the consolidation of facilities. CAT announced in 2015 that it would take significant restructuring and cost-cutting measures to reduce operating costs by about $1.5 billion annually once fully implemented. The restructuring measures began in late 2015 and reflected current and expected market conditions. Caterpillar planned to permanently reduce the salaried and management workforce, including agency, by 4,000-5,000 people between 2015 and the end of 2016. The announcement followed significant actions already taken since 2013, including closing or consolidating more than 20 facilities and reducing the total workforce by more than 31,000 since mid-2012. Pre-tax costs associated with these actions were expected to be about $2 billion.

These initiatives seem to have worked on gross margin as they improved materially. However, the picture of SG&A is not as straightforward as it stayed above $4.3 billion.

The Bipartisan Infrastructure Deal

The Bipartisan Infrastructure Deal presents an opportunity for companies like CAT to benefit from investments in rebuilding America's infrastructure, including roads, bridges, rails, water access, and high-speed internet. The legislation also targets supply chain strengthening and inflation prevention with investments in ports, airports, and railways.

The deal's total value is $1.2 trillion spread over eight years, with roughly $550 billion in new federal spending. CAT's primary benefit is expected in roads and bridges, as the bill invests $110 billion in repairs and rebuilding efforts. Additionally, CAT could partially benefit from other sections of the bill, such as the $17 billion in port infrastructure and waterways and $25 billion in airport maintenance and repairs.

China's Growing Demand for Mining Equipment Could Offset the Decline in Capex Investments Expected in 2023

Total capital expenditure in the mining industry across 13 different commodities will likely fall by $11 billion in 2023, primarily driven by declines in development capex for iron ore and gold projects. Similarly, Fitch Solutions expects mining capex into new project developments to be hit hard in 2023, with companies allocating funds to brownfield operations and lowering their risk appetite. However, some miners may still invest in projects aligned with their strategic goals or market opportunities. For example, Nexa Resources ( NEXA ) announced a capex plan worth $310 million for 2023, a reduction from previous years. Still, they focused on advancing its Aripuanã project, which is expected to start production during the year. Another example is Fortescue Metals ( FSUMF ) which predicts capex to fall to between $2.7 billion and $3.1 billion in 2023 relative to $3.1 billion in 2022 but also plans to invest in renewable energy projects.

Over the past decade, China's demand for mining equipment has grown rapidly. It is expected to continue increasing over the next decade due to sustained high-speed economic growth. This growth has been driven by consecutive increases in industrial output, imports and exports, consumer consumption, and capital investment for over two decades.

CAT to Benefit from Oil and Gas Capex Increase in 2023

CAT will likely benefit from increased sales of engines, transmissions, and pumps due to higher capital expenditures in the oil and gas industry. The expected rise in spending is due to a rebound from the pandemic-induced downturn and the need for companies to invest in new projects and technologies. Wood Mackenzie forecasts a 5% increase in investment across various sectors, including oil, gas, power, renewable energy, metals, and mining, reaching $1.1 trillion in 2023. In particular, the upstream oil and gas sector is expected to see a 10% increase in capital spending, rising from $370 billion in 2020 to $470 billion in 2023, driven by increased demand for oil and gas due to the reopening of China's economy and the energy crisis in Europe. Energy Intelligence expects even stronger growth, with a 12% increase in capital spending in the same sector.

Valuation

Based on my DCF valuation using a cost of capital of 7.2% based on an unlevered beta for heavy machinery of 1.09 , I believe that CAT's shares are fairly priced. My DCF valuation is $250 per share. While I anticipate that margins will remain aligned with post-2018 levels at 27%-29%, my valuation heavily relies on revenue assumptions. Specifically, I expect that the construction segment's revenues will increase by approximately 10% in the near future, primarily driven by the US infrastructure deal. Although machinery sales in the mining segment are expected to remain stagnant, I anticipate revenues from the maintenance of older equipment will increase. In the energy sector, I predict revenues will increase by approximately 5-7%.

Risk

Risks to CAT include declining investment in mining capital expenditures. While the US infrastructure deal and rising demand for new roads in emerging markets provide some short-term opportunities, investment in construction spending can quickly decline during economic slowdowns.

Additionally, a potential slowdown in global economic activity could soften the demand for oil. If commodity prices drop worldwide, mining and oil-well-servicing customers may reduce their capital expenditures.

CAT also faces competition from foreign rivals, primarily Komatsu ( KMTUY ) and Chinese companies such as Sany ( SNYYF ) and Zoomlion ( ZLIOY ). Although the latter two have slightly increased market share, they still generate most of their revenue from China. Still, it is possible that these firms could improve their product quality and build dealer networks to rival CAT's.

Conclusion

CAT has maintained its competitive advantage due to its trusted brand, extensive dealer network, and superior products tailored to individual customer requirements. The Q4 results show that the company finished the year strong, with machinery sales surging by 21% YoY. With the Bipartisan Infrastructure Deal and the expected increase in oil and gas capex, CAT has opportunities for growth that will likely offset the decline in capex investments in the mining industry.

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