Will US infrastructure spending lift this bellwether stock?

Caterpillar (US:CAT) is a deservedly iconic brand when it comes to moving large amounts of earth around in the shortest possible time. Indeed, the distinctive yellow and black branding finds its way onto clothing, footwear and children’s toys. In short, it is a company with a globally recognised presence, a heritage of strong research and development (R&D), products with consequently wide moats in terms of intellectual property, and access to a very large Stateside construction market. With the shares currently hovering around the long-term average price/earnings (PE) ratio of 16, the company could be ready to boost its value in earnings terms if the infrastructure spending unlocked by the recent deal on the US debt ceiling translates into enough demand for the company’s earth-moving products. Complicating the picture is the question of whether spending by government agencies will ‘trickle down’ to individual companies and thereby positively affect their stock market valuations. The other reason for investor interest is that Caterpillar is considered something of a bellwether share for institutions that hold large amounts of capital on behalf of retail investors. For example, market tracker specialist and fund manager Vanguard is the company’s biggest shareholder. If America’s revival in manufacturing and reshoring from overseas markets shows any tangible benefit, then Caterpillar should feel it. However, while there could be a scenario where the company becomes more profitable, the interest rate picture means the shares might struggle to break out from their average price/earnings (PE) ratio as investors find alternative ways of earning a return. Interest rate s are the key While great hopes are pinned on infrastructure spending benefiting various sectors, from manufacturing to basic materials, investors first need to understand how interest rates affect the flow of capital between the stock market and the bond market before placing bets on an all-out bull market in equities. With the US base rate at 5.25 per cent and climbing, there seems to be a strengthening case that stock market performance owes more to government monetary policy than to what it spends. For example, academics Efrem Castelnuovo and Salvatore Nisticò reckon that interest rates and the stock market pricing of equities are both forward-looking in their expectations of future prices, so therefore have a natural relationship. Problems arise when interest rates reach a level that makes the bond market inherently more attractive than equities, as bond pricing will respond more readily to interest rate movements. In short, while there seem to be several complex interactions between interest rates and market prices, the higher interest rates climb, the lower the returns expected from equities – whether capital gains or income from dividends. Read more on our US portfolio The stocks benefiting from America’s infrastructure boom Why it’s time to remember America’s forgotten industrials How does this affect cyclical companies such as Caterpillar? Much of the investment case rests on how much money the company earns from the latest round of government spending. Like most first-world countries, the US has an acknowledged problem with large parts of its public infrastructure and utilities, as several alarming bridge collapses over the past decade have illustrated to deadly effect. Many states have roads, water pipes, bridges and other infrastructure that simply need huge upgrades. According to the $1.2tn “Infrastructure Investment & Jobs Act”, approximately $110bn is set aside for road and bridge rebuilding, $17bn for ports, and $55bn for water projects, amongst other areas. The list is impressive, but needs to be interpreted with nuance. For instance, while rebuilding bridges will create demand for new heavy lifting equipment, the same can’t be said for the $39bn that will be used to improve access to public transport, or the $7.5bn for building electric vehicle points. Interestingly, the total proportion of spending in different areas linked to construction projects would roughly match the percentage of revenues that Caterpillar generates from its different business segments; construction makes up 42 per cent of total revenues, for instance. CAT-US Company Details Name Mkt Cap Price 52-Wk Hi/Lo Caterpillar Inc. (CAT) $123bn $237.90 26,604c / 16,060c Size/Debt NAV per share* Net Cash / Debt(-)* Net Debt / Ebitda Op Cash/ Ebitda 3,083c -$30.2bn 2.6 x 90% Valuation Fwd PE (+12mths) Fwd DY (+12mths) FCF yld (+12mths) CAPE 13 2.1% 6.6% 28.0 Quality/ Growth EBIT Margin ROCE 5yr Sales CAGR 5yr EPS CAGR 17.2% 17.4% 5.5% 58.6% Forecasts/ Momentum Fwd EPS grth NTM Fwd EPS grth STM 3-mth Mom 3-mth Fwd EPS change% -8% 7% 4.8% 11.4% Year End 31 Dec Sales ($bn) Profit […]

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