Caterpillar Inc. (CAT), the world’s largest manufacturer of construction and mining equipment, is seeing its profits squeezed amid the ongoing U.S.­-China trade war and slowing global economic growth. The company’s shares are also feeling the weight, having fallen about 19% from their peak closing-high back in January 2018. They are up nearly 5% on the year, but still lagging the broader market by about 15%. 

Recent positive trade news, including planned talks between the two countries in Washington and tariff exemptions on some U.S. goods by China, have lifted the stock in recent days. But if there is one lesson to be learned from the trade war, it’s that positive news can quickly dissipate. The trade war isn’t over until both countries have resolved their issues in a formal trade deal. It could be a while before that happens.

Key Takeaways

  • Trade war and slow global growth squeezing profits.
  • Stock, down 19% from peak in January 2018, lags the market.
  • Significant weakness in construction and energy and transportation.
  • High equipment inventories indicate sluggish demand.

What It Means for Investors

Caterpillar faces a number of near-term headwinds, according to Bank of America analyst Ross Gilardi. Both the construction and upstream oil and gas industries are exhibiting weakness. He estimates that earnings from the company’s construction segment will decline by 30% from peak to trough, while the energy and transportation segment will see a decline of 15%. 

While those declines should be slightly offset by a 5% gain in Caterpillar’s mining earnings, Gilardi added that the capital expenditures (CapEx) outlook in oil and gas is not looking great and forecasts continue to trend to the downside. He figures the company could face another one or two quarters of negative EPS revisions and moderately weaker earnings throughout 2020. 

Longer term, Gilardi is optimistic. He advises investors to look beyond the near-term weakness in EPS, as global PMIs are beginning to hit their bottoms and the U.S service economy is still in good shape. He reiterated Bank of America’s buy rating on Caterpillar, adding that the steady growth expected in the mining industry and additional stimulus from global central banks will help to push the stock’s price higher.  

Not all analysts share Gilardi’s long-term optimism. Analyst Ashish Gupta of brokerage firm Stephens, concerned about the U.S.–China trade war and the outlook for global growth, noted his firm’s underweight rating on the stock last month. Despite the shift to easier monetary policy, he’s not expecting a flood of liquidity from central banks to suddenly boost economic output. 

Slowing growth in the Chinese economy will have especially negative impacts on the entire resource industry, an industry replete with some of Caterpillar’s biggest customers. In its second quarter earnings report issued at the end of July, the company indicated that a 22% drop in its Asia-Pacific unit’s construction sales was largely due to weak demand in China. The company also noted that tariffs were one of the reasons its manufacturing costs were higher.

The slowness in the construction industry has already exacted a heavy toll on demand for Caterpillar’s construction equipment. Gupta points to the company’s currently higher equipment inventories as an indicator of the sluggish demand. “For Caterpillar, the excess dealer inventory means lower reported sales in coming quarters,” wrote Gupta in a research report published last month, according to Barron’s.

Looking Ahead

To be sure, Gilardi’s thesis that supports his long-term optimism is that all of these headwinds are already factored into Caterpillar’s current stock price. If he’s right, investors could purchase the stock for a bargain at its current price and when the economic outlook brightens they could be well rewarded.