Summary
- Growth should remain healthy.
- Despite headwinds from key markets, mainly North America, and China, Caterpillar's stock will be rangebound.
- Growth will be secular and long-term from here on in.
Caterpillar (CAT) has been performing relatively well in recent times. In the latest quarter, the company witnessed a significant increase in revenue, which grew by 20% to $16.6 billion, leading to a 43% increase in earnings per share to $3.86. The stock is up close to 30%, over a 52-week period.
Throughout 2022, as a result of increased government spending, the construction division witnessed a larger increase in revenue, compared to the other major divisions. Global infrastructure spending has been much higher over the past few years, as the government spent record levels in order to overcome the recessionary effects of the pandemic. The largely $1.2 trillion bill played a key role in increasing spending.
Furthermore, the commodities industry also witnessed a significant increase in spending as well, as prices were significantly higher. The increase in demand especially from the renewable and sustainability industries, lead to a significant increase in revenue for the industry, segment for Caterpillar, with revenue increasing by mid double digits.
The energy and transportation industry also outperformed as demand for energy continued to increase revenue continues to be the oil & gas industry, industrial, and transportation industries. Energy and industrials continue to outperform as we continued to witness strong demand across the sector during the year.
Where Are We Headed In 2023?
Infrastructure
Going into 2023, Caterpillar's divisions are facing a mix of headwinds, and tailwinds, as rising interest rates are likely to dampen sentiment, as global spending, continues to slow down. Furthermore, there are clear indications that governments are interested in managing fiscal deficits , especially in 2022, and whatever deal is achieved will likely lead to a slowdown in infrastructure spending.
Secondly, China has been increasingly grappling with a crisis as well, as years of over-investment in infrastructure are now leading to a correction where, when combined with the supply chain issues, Caterpillar witnessed a fallout during the previous quarters . This combination of slowing global spending, and China's economic woes, is likely to put pressure on Caterpillar's revenue in 2023. China is trying to reduce the effects slightly by focusing on fiscal spending , but will also wait and watch, to see if consumer spending will help to offset some of the economy's woes. In addition, the effects of the slowdown in the real estate market , could also affect demand for Caterpillar, real estate prices continue to fall, leading to the asset coming less in demand, and with all the excess inventory, it could be a long time before the sector recovers.
Some of the pressure was offset by Caterpillar increasing prices in 2022, but after almost 18 months of inflation, it's unlikely that prices can be increased as much as Caterpillar might want to in 2023. This means that slowing revenue, and prices, may cause a small contraction in margins.
The infrastructure sector faces a lot more headwind in 2023, as lower spending from governments, and economic issues continue to weigh on the division.
Resources and Energy
Additionally, the commodities and energy/industrial divisions will be under pressure as well. While I expect the oil and gas industry to continue to see steady demand when compared to the resources division, increased demand from emerging markets and China's reopening is likely to lead to an increase in demand for energy. On the other hand, the resources industry may witness a pullback, as a slowdown in spending from consumers is likely to lead to a fall in demand for commodities. This may result in revenue coming in the lower double digits in 2023, compared to the higher rate of growth in 2022.
Commodities have retreated as the increasing rates, lower liquidity, and reduced demand have led to prices moderating. This in turn should lead to lower mining activity overall. Key commodities such as lithium, and copper, both of whom witnessed a significant increase in demand recently, may see lower growth in 2023, than had been initially anticipated, which means that Caterpillar equipment may face lower demand and growth as well.
On the other hand, slowing inflation could help improve demand and keep margins steady. In 2022, Caterpillar witnessed higher prices and input costs , which were largely offset by Caterpillar's own price increases. These prices are likely to moderate in the coming year, as the company faces fewer inflationary pressures. Global inflation is already starting to come down but remains sticky at the current level, and this is likely to mean equipment pricing will also remain rangebound.
Global opportunities and backlog should help to continue to drive revenue
Caterpillar will increasingly look to other global markets as major markets continue to face headwinds, they have already started making inroads into key countries in Africa, Latin America, and the Middle East. All these geographies will witness higher growth than developed markets, and China, which should help offset some of the revenue. Mining activity has been increasing in the African continent and the resources division may likely see an uptick in mining activity there. This could help to continue to drive revenue in the near future, as other geographic locations continue to struggle.
Furthermore, the company does have a backlog , which should help offset some of the slowdowns, with multiple contracts from Chile and Latin America.
Caterpillar's management has indicated that its 2023 backlog should help continue the run that it witnessed in 2023. - "But again, we are pleased with the way that the team performed in the year. And we talked about the fact that we still have supply chain struggles that we're dealing with, but we also have strong demand across most of our end markets".
Where might the stock be headed?
Analysts have also been a lot more moderate in their predictions for 2023, with average predictions looking at around 9-10%. Considering that discount rates are up and the current dividend is around 2%, Caterpillar's stock could see a small correction before heading back up. But even then, the upside is likely limited as investors won't be betting on the same outperformance it witnessed in the current year. Caterpillar won't be the high-flying stock that it was in 2022, and investors should invest if they're looking for longer-term value.
For further details see:
Caterpillar Won't Be The High Flying Stock In 2023 That It Was In 2022