With Donald J. Trump soon to be inaugurated as the 45th President of the United States and the Dow Jones Industrial Average soaring to record highs since his election in November, many investors are likely wondering which sector or industry offers the best opportunity to capitalize on what many are calling the “Trump rally”. While there are several areas of the economy that are poised to benefit from the President-elect’s campaign promises, in this review we will focus on one in particular, infrastructure. Indeed, we shall take a look at how heavy construction equipment manufacturer and Dow-30 member Caterpillar (CAT – Free Caterpillar Stock Report) could fare under the incoming administration.
One major theme that President-elect Trump’s campaign centered on was U.S. infrastructure and the need to repair it, with plans to spend roughly $1 trillion for this purpose over the next decade or so. Despite some ambiguity in terms of how those funds will be raised or if political roadblocks could derail his plans, and exactly which projects will be included in the proposal, the message seemed to resonate with voters. And it apparently also struck the right chord with the bulls of Wall Street, as infrastructure-related stocks, such as Caterpillar, jumped in the days and weeks following Trump’s election win. The stock’s price hit a high of $97.33 in early December, well above the recent price shown on the Top Label of our latest report published on November 18, 2016. But is the latest news enough to support sustainable stock price gains? And, with so many flocking to this issue, does this mean investors have already missed the boat?
To address these concerns, we first start by considering a few things displayed in the Value Line report. For example, looking at the Statistical Array in the center of the page, it would be hard not to notice that the company’s sales and earnings have been slipping since peaking in 2012. According to analyst Dominic Silva’s estimates, as shown in the Array and Quarterly Revenues and Earnings boxes, the industrial titan, which manufactures a range of mining equipment and machinery used in such markets as construction and oil & gas, may well see its earnings per share slide and possibly plateau in the near term amid ongoing top-line weakness. That’s based on management’s expectations that operating conditions in 2017 will be similar to those of last year, as discussed in the Commentary section. Indeed, used and idle machinery in North America and lower international demand against a weak global economic backdrop have been the main culprits behind CAT’s recent struggles. Competition, mostly from foreign equipment makers, has not helped matters, either, as rivals have sought to grab market share from CAT, not just on the international front but on the domestic side, too.
Assuming Trump’s $1 trillion infrastructure plan (or some form of it) is passed, Caterpillar’s fortunes could well turn for the better. Under such a plan, the company (at least its domestic segment, which represents just under 50% of its total sales) would essentially benefit from the boost in end-market demand that’s likely to result as roads, highways, bridges, hospitals, schools, and the like get repaired or are newly constructed. Can this help pave the way then for a brighter future for the equipment manufacturing giant? That partly depends on other factors besides the actual infrastructure plan, including taxes and other business-friendly incentives, which, under a Trump presidency, are expected to be favorable.
Admittedly, when looking at the Value Line page, CAT stock seems to lack appeal at first blush. The issue gets only a 3 for Timeliness (Ranks box), or year-ahead price performance relative to the broader markets, making it an average choice for the short term. The equity does not stand out for the long term, either. At the price shown at the top of the page, it offers modest capital gains potential 3 to 5 years out, as illustrated in the Projections section. What’s more, CAT is fairly richly valued, as the P/E and relative P/E (Top Label) imply; both are near historical highs. Realize that the latest rally has made the stock even more pricy from a P/E perspective, suggesting the issue may have gotten a bit ahead of itself.
On the other hand, there are several positive attributes that shouldn’t be overlooked. Notably, the blue chip features a Safety rank of 2 (Above Average), as displayed in the Ranks box, implying that CAT carries less risk versus the typical stock under our coverage. That largely reflects the company’s almost perfect score of A+ for Financial Strength, and the stock’s decent grade of 70 for Price Stability, measures found in the Ratings section.
The Dividend Yield (Top Label) is, by far, the biggest draw on the page. At 3.6%, Caterpillar stock offers a good chunk of income at that quotation. (Again, the equity’s price run-up since our November writing has now lessened the yield to about 3.3%, a still-solid return.) Although the annual payment is expected to rise at a modest pace out 2019-2021, CAT is, nonetheless, best suited to conservative, income-minded types. Those betting that Trump’s $1 trillion infrastructure proposal will be a potential opportunity for the industrial giant might want to keep Caterpillar on their radar, too, and hop aboard on a price pullback. As the analyst concludes in the Commentary, “a well-covered, above-average dividend payout would make the wait for a turnaround here a bit more palatable”.