Does Buying Caterpillar At $100 Make Sense?

The market has ignored the likes of famed short-seller Jim Chanos, pushing Caterpillar (CAT) higher over the past half-year. Since going against Jim Chanos in late July Caterpillar is up nearly 20%. At the time, I was looking for growth to $120 share. That still leaves 25% upside to the equipment giant. Getting us there should be an upturn in the mining equipment market, where Caterpillar is already seeing increased “quoting” activity on original mining equipment. The outlook for construction also seems to be optimistic and China is still a very appealing market for the equipment making giant.

Cost savings helps boost earnings

Restructuring should continue to be one of the quickest and easiest ways for the company to boost margins, ultimately growing earnings. Its cost savings program is spread across its global footprint. This has helped boost earnings despite flat revenue growth. During the fourth quarter revenues were down 10% Y/Y, earnings were up 5%. This was a result of Caterpillar’s efforts to cut costs.

Caterpillar managed to save over $700 million in 2013 by lowering SG&A and R&D, as well as some manufacturing costs. Additional restructuring initiatives are expected to save another $200 million in 2014 and upwards of $400 million in 2015.

China is well covered, but still flies under the radar

Mining companies have been cutting CapEx as weakness in the mining sector continues. While this may continue for 2014, looking beyond that to 2015, mining should pick up materially. Driven by increased demand in Asia, where China accounts for about 50% of the continents mining CapEx.

Specifically for Caterpillar, the company saw excavator sales up 20% Y/Y in December. This marked the third straight month of 20% plus growth in Chinese excavator sales. .

Don’t not forget that Caterpillar is a major player in the construction segment. In a recent report from ARCADIS, the global engineering and consulting company, it reported that the global construction market will grow by more than 70% to reach $25 trillion by 2025 with India, China and the U.S. accounting for 60% of the growth. China and India will need to build 270 million new homes by that year.

Bottom line

Much of the construction equipment market was drug down by the interim issues the resource industry was facing. However, its the long-term I’m more interested in. The price target to $120 is still intact, with profits in the interim being driven by cost cutting, and longer-term, revenues from China should be a key driver.