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Strong Demand in End Markets Aids Caterpillar (CAT), Costs High

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Caterpillar Inc. (CAT - Free Report) is poised well to benefit from solid backlog levels, improving demand in most of its end markets and cost-control efforts. A robust liquidity position, investments in expanded offerings, and services and digital initiatives are expected to fuel growth as well. Impact of high input costs and supply chain headwinds are likely to impact results in the near term.

High Demand to Offset Inflated Costs in 2021

Caterpillar’s revenues increased 29% year over year to $12.9 billion in second-quarter 2021. The company’s backlog at the end of the reported quarter was $18.4 billion, which was up $1.5 billion on a sequential basis. This bodes well for the top-line performance in the forthcoming quarters.

The company has been witnessing higher material costs, particularly of steel and other commodities. This along with higher freight costs, labor constraints and supply chain headwinds are expected to hinder margins this year. The headwind from incentive compensation is anticipated be about $1.5 billion for the year. This will lead to higher SG&A expenses through the year. The company is ramping up R&D project spending to support services growth strategy and new product development. These factors will hurt margins this year. However, the company’s ongoing restructuring efforts and higher demand in its markets will help negate this impact.

Segments Poised Well for Growth

In North America, demand from both residential and non-residential construction will bolster sales for Caterpillar’s construction equipment. With the U.S Senate passing the $1-trillion infrastructure bill, the perked-up investment in roads, bridges, airports and waterways represents a huge opportunity for Caterpillar. The outlook for the construction sector holds promise in the rest of the world as well.

In Resource Industries, mining orders are on an uptrend, courtesy of improving metal prices. There has been an improvement in heavy construction and quarry and aggregates, particularly in North America and the EAME. This is anticipated to continue through the year. Miners are bringing radical changes to mining operations to increase productivity and reduce costs and are, thus, increasingly relying on autonomous systems. Hence, Caterpillar is enhancing its autonomous capabilities and bringing innovative products to markets that provide it with a competitive edge in mining.

In the Energy & Transportation segment, the Oil & Gas sector is expected to continue to strengthen gradually. The company anticipates improvement in power generation, supported by data center activity. It expects sales to improve in transportation, courtesy of an increase in rail services and international businesses. It anticipates modest growth in the marine business as well. Industrial is expected to see growth, with activity strengthening across most applications.

Solid Balance Sheet to Drive Growth

In the first half of 2021, Caterpillar generated Machinery, Energy & Transportation (ME&T) free cash flow of $3.4 billion and remains on track to deliver its ME&T free cash flow target of $4-$8 billion for 2021. Its cash and liquidity position remains strong with the company ending second-quarter 2021 with cash and short-term investments of $10.8 billion. ME&T debt at the end of second-quarter 2021 stood at $9.7 billion.

Caterpillar’s current ratio is at 1.56 and the times interest earned ratio is currently at 6.5. The company recently hiked its quarterly dividend by 8% to $1.11 per share. Its current dividend yield is 2.03% — higher than the industry’s 1.98%. It has a five-year dividend growth rate of 8.6%.

The company continues to focus on customers and the future by continuing to invest in digital capabilities, connecting assets and job sites along with developing the next-generation productive and efficient products. The company plans to fund initiatives that drive long-term growth focused on areas of expanded offerings and services, and digital initiatives like e-commerce.

Price Performance

Zacks Investment Research
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Shares of Caterpillar have gained 44.7% in a year compared with the industry’s rally of 46.4%.

Zacks Rank & Stocks to Consider

The company currently has a Zacks Rank #3 (Hold).

Some better-ranked stocks in the Industrial Products sector include Encore Wire Corporation (WIRE - Free Report) , Lincoln Electric Holdings, Inc. (LECO - Free Report) and Lindsay Corporation (LNN - Free Report) . While Encore Wire and Lincoln Electric Holdings sport a Zacks Rank #1 (Strong Buy), Lindsay carries a Zacks Rank #2 (Buy), at present. You can see the complete list of today’s Zacks #1 Rank stocks here.

Encore Wire has a projected earnings growth rate of 332.6% for fiscal 2021. In a year’s time, the company’s shares have gained 60%.

Lincoln Electric has an expected earnings growth rate of 45.1% for 2021. The stock has appreciated 40% in a year.

Lindsay has an estimated earnings growth rate of 17.3% for the ongoing year. The company’s shares have rallied 62% in the past year.