This paper presents a private equity investment analysis of Caterpillar Inc. (CAT), one of the world's leading manufacturers of heavy construction machinery. The paper traces the company's origins from its 1925 founding through its global expansion, then examines recent financial performance, including declining operating profits between 2006 and 2010, alongside sustained investment in research and development and dividends. The analysis evaluates macroeconomic factors — including U.S. quantitative easing, inflationary pressure, and the post-recession recovery — to assess CAT's valuation. It also explores future growth opportunities in emerging markets such as India and China, concluding that a private equity acquisition target price in the range of $90 to $115 USD is appropriate given current market conditions.
Caterpillar has a rich history in the United States as one of the remaining engineering and manufacturing firms from the immediate post-industrial revolution era. The company has obtained a global sphere of influence, with products penetrating markets and capturing market share throughout the world. Given recent quantitative easing by the U.S. Federal Reserve — in the form of purchasing outstanding bonds — the Fed created liquidity in the market and flooded it with dollars.
Subsequently, the resulting inflationary pressure pushes stock prices higher as the value of the dollar declines, requiring more dollars to purchase a share of stock. Purchasing the stock at its current price would therefore be inadvisable given the inflationary effect. Caterpillar is nonetheless an attractive company and a sound investment target. However, the valuation of the company will price its assets at a premium given the cost of capital and the prevailing rate of inflation.
There are various ways of acquiring Caterpillar. Should the acquiring company use equity shares, those shares will likely trade at a premium to Caterpillar. Additionally, the acquiring company can use a combination of cash and equity, along with issued debt, to finance the acquisition. Given the strength of stock market appreciation, positive market sentiment, and the market's unwillingness to surrender returns in the face of inflation, the equity price of Caterpillar is likely to trend higher. An acquisition target price of $90 to $115 USD is therefore advised. The equity value is likely to retract from its current trading pattern, creating buying opportunities within this range.
Caterpillar is a global supplier of heavy machinery such as tractors and excavators used at construction sites for commercial and residential building development, parking garages, and similar projects. Although Caterpillar's profits dipped over the most recent operating year, strong global demand is expected to drive long-term growth. The stock price has not fully reflected the weakness in global markets or the decline in industry sentiment. Caterpillar continues to pay a substantial dividend and invests retained earnings in research and development.
Caterpillar is a twentieth-century company with nineteenth-century beginnings, tied to the late period of the American Industrial Revolution. The company was formed in 1925 by two visionary thinkers who envisaged what would become the Caterpillar Company (CAT, 2011). Those men — Benjamin Holt and Daniel Best — were engineering and manufacturing professionals with an extreme commitment to quality, innovation, and customer value (CAT, 2011).
"The Holt Manufacturing Company and the C.L. Best Tractor Co. merge to form Caterpillar Tractor Company" (CAT, History, 2011). The merger consolidated the two businesses into one unified firm that manufactured "tractors, motor graders, generator sets and a special engine for the M4 tank" (CAT, 2011). The major customer of the newly formed firm in its early years was the U.S. government, to which Caterpillar provided parts and machinery to support the war effort during World War I and World War II.
The second half of the twentieth century positioned Caterpillar for further growth as global markets expanded into Asia and the Asia-Pacific region. A joint venture between Caterpillar and Mitsubishi was formed to concentrate on pursuing Caterpillar's interests in Japan (CAT, History, 2011).
The early 1980s brought a global recession that significantly affected CAT's operations (CAT, History, 2011), "costing the company the equivalent of $1 million a day and forcing it to dramatically reduce employment" (CAT, History, 2011). Although periods of recession were somewhat cyclical throughout CAT's history — with the notable exception of the period between 1929 and 1933 — the company recovered and continued to diversify its asset base (CAT, History, 2011).
The 1990s and 2000s saw tremendous growth in the CAT brand, as its new line of compact construction equipment received strong support in the marketplace (CAT, History, 2011). Caterpillar is currently one of the most recognized brand names in the global construction equipment market, with contracts across the world in both public and private industry applications.
Caterpillar's future performance must be understood in the context of a considerably changed global environment. Construction and development activity has been substantial in the Middle East, which has historically been one of Caterpillar's stronger markets. Global demand for construction equipment is likely to remain robust once the current global economic crisis abates. Strong demand also exists in Asian markets, including China and Indonesia.
Additionally, India represents a significant future opportunity for CAT. "Caterpillar is committed to achieve market leadership in India for which we will continue to explore and develop products that will meet the Indian market requirements and leverage regional and global product strategies to allow synergies with this country. As part of the strategic plan to increase our manufacturing footprint in the rapidly growing Asia-Pacific region, Caterpillar Inc. (NYSE: CAT) announced in 2008 a four-year, $200 million investment to increase manufacturing capacity in India." (NBM & CW, 2011)
Furthermore, broader economic conditions for CAT's operations appear to be improving relative to the wider market, despite the recent economic downturn. "The ratings and outlook affirmation for CAT reflects the improving global economic outlook, the benefits of cost reductions last year, a solid liquidity position and improving credit metrics. The ratings continue to reflect CAT's competitive products, diversified customer base, global manufacturing footprint and strong international dealer network, which are helping the company rebound from the trough." (Business Wire, 2010)
Of considerable importance is the following observation: "An upturn in spending by businesses or indications that companies are raising investment plans would be significant." (Aeppel, Tuna, & Lahart, 2009). Once the economic slowdown troughs and begins to recover sharply, investment in Caterpillar products is forecast to surpass demand from the broader market.
The methodology for determining whether Caterpillar represents a strong investment begins with establishing whether the company is undervalued relative to the current market. At the time of this analysis, the current stock price was $110.18 USD. Considering the five-year chart, the company was trading at the high of its five-year range, well above a prior trading range of $70 to $80 per share. The price-to-earnings (P/E) ratio stood at 19.82.
"Methodology criteria and current stock metrics"
"Revenue and profit figures from 2006 to 2010"
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