NWQ Managers (Trades, Portfolio) is a value-oriented money management firm with several funds products, and more than $54 billion under management. Professionals with the company have an average of 22 years experience.
The firm does bottom-up research on companies and industries focusing on qualitative factors such as restructuring, management strength, shareholder orientation and the ability to capitalize on improving industry fundamentals. In addition, a broad range of quantitative valuation screens are applied including, price-to-cash flow, price-to-book, price-to-earnings and quality of earnings. They focus on three factors: attractive valuation, downside protection, and identifying catalysts and inflection points.
Last quarter, the firm initiated a long position in Caterpillar's (CAT) buying 64,600 shares. Caterpillar is the world’s leading manufacturer of construction and mining equipment, diesel and natural gas engines, industrial gas turbines and diesel-electric locomotives. The company principally operates through its three product segments – Resource Industries, Construction Industries, and Energy & Transportation (formerly Power Systems) – and also provides financing and related services through its Financial Products segment. Caterpillar is also a leading U.S. exporter. Through a global network of independent dealers and direct sales of certain products, Caterpillar builds long-term relationships with customers around the world.
The company’s shares are under pressure since the back half of 2014. The key culprit is the fall in oil prices that has impacted the company’s 2015 outlook. According to Caterpillar’s latest 2015 outlook, sales and revenues are expected to be about $50 billion in 2015, which is down about 9% from 2014 levels. Management expects continued weakness in commodity prices, particularly oil, copper, coal and iron ore. The sales will be hurt by several factors, but the single biggest factor is direct and indirect impacts from oil and gas price declines. About half of CAT's 2015 sales decline is expected to come from direct and indirect exposure to oil and gas. The other factors include decreases in mining and the stronger U.S. dollar, decreases in locomotive sales, lower China construction industry and industrial engines.
For the year management expect profit per share of $4.70 and excluding restructuring costs at $5.00. On the positive side, lower incentive compensation expense, improved variable margin, lower restructuring costs, positive currency effects and slightly improved price realization are expected to help the company’s profitability.
In a nutshell, 2015 is going to be a tough year for Caterpillar. However, this is already factored in the company’s stock price, and the big question now is whether the company’s 2015 guidance marks the bottom for the company. I believe the worst is already factored in the company’s updated guidance. Oil prices seem to be bottoming while the dollar is also stabilizing. Sell side analysts are expecting the company’s top line to remain flattish and its EPS to increase in FY2016.
Analysts at Baird recently upgraded the stock to outperform citing cyclical bottom in commodities markets. According to Baird analyst Mig Dobre, the decline in commodity prices over the last several years is similar to the 1980s bust, and anything worse is unlikely, given the significant stimulus from central banks around the world. He also said that Caterpillar’s stock typically bottoms before the actual bottom in the mining business and "waiting for confirmation from improvement in bookings could mean being late to the party."
Mig Dobre is not alone in terms of his cyclical bottom thesis. Fund manager Bill Nygren (Trades, Portfolio) shared similar view in his recent investor letter. He wrote,
“Caterpillar is the world’s largest provider of construction equipment, diesel engines and industrial gas turbines. Caterpillar’s products earn high marks, as do the quality and scope of its dealer network, but the company has considerable exposure to the highly cyclical and currently depressed oil and gas and mining segments. With substantial pressure from weak energy spending and the negative impact of the strong U.S. dollar, Caterpillar’s 2015 earnings will likely be down considerably from 2014 and toward the bottom end of their cyclical range. We prefer to value cyclical businesses on their earnings potential throughout the cycle, and we think that Caterpillar’s mid-cycle earnings will be considerably higher than current levels. With the Caterpillar share price falling to multi-year lows, the business is now attractively valued at just 10x our forecast of mid-cycle earnings. When we combine this attractive valuation with a 3.4% dividend yield and a strong balance sheet, we find Caterpillar to be a compelling investment.”
Caterpillar is trading at a forward PE of 16.14 and has a forward annual dividend yield of 3.40%. I expect the company to be more aggressive in terms of buybacks and restructuring going forward. The company’s medium to long term prospects looks good. Long-term investors should look to buy this quality large cap stock cheap at current levels.
