Cat or Deere or Neither?
publication date: Nov 5, 2020
author/source: Brian Nelson, CFA
Image: Deere equipment. Deere's stock has been a high-flyer during the past several months.
By Brian Nelson, CFA
The SPDR S&P Metals and Mining ETF (XME) measures a broad swath of entities tied to the metals and mining sector, weighting names such as Cleveland Cliffs (CLF), United States Steel (X), Arconic Corp (ARNC), Worthington Industries (WOR), and Freeport-McMoran Inc. (FCX) near the top. It also includes one of our favorite miners, Newmont Corp (NEM), but we generally don’t like the metals and mining space, more generally.
Year-to-date, the sector is down ~17% and ~11% during the past 12 months; meanwhile, the S&P 500 is up ~7% year-to-date as it has advanced ~12% during the past 12 months. Metals and mining stocks, for the most part, have been material underperformers recently. As with Newmont, investors have to pick their spots wisely in the metals and mining space, and perhaps avoid it altogether by considering ancillary plays such as Caterpillar (CAT) and Deere (DE)--both up year-to-date, with the latter significantly.
But which one is better? Cat or Deere or neither?
Caterpillar Facing Hefty Sales/Profit Declines
It’s a difficult business to be a cyclical industrial these days, especially as COVID-19 continues to spread. Caterpillar released third-quarter results October 27 that showed revenue dropping 23% and profit per share declining 54% versus the same period last year. Investors in Caterpillar should be used to these wild swings in revenue and earnings through the course of the economic cycle (with the company still managing to raise its dividend each year for the past 27 consecutive years), but it doesn’t make the up-and-down performance easier to stomach.
That said, Caterpillar has a relatively liquid balance sheet to ride out the COVID-19 storm. The company held an enterprise cash balance of $9.3 billion at the end of the third quarter and has over $14 billion in available liquidity sources, including a revolver (“corporate credit card”) and commercial paper programs. Long-term debt in its Machinery, Energy & Transportation division stood at $9.7 billion, so management is doing a good job managing liabilities. Its financing arm holds a total of $19+ billion in short and long-term debt. Moody’s rates its debt A3, while other major credit ratings give it “mid-A” marks.
Deere Has Better Visibility
Deere’s performance, on the other hand, has been comparatively better than Cat’s, in our view, and its share price has revealed as much. Though under pressure as well, Deere’s worldwide sales fell 11% during its fiscal third quarter (ending August 2, 2020), while EPS came in at $2.57, down a modest 8.5% from the year ago period. These declines are much more muted than Caterpillar’s top-and bottom-line declines during its most recent quarter.
Deere is targeting fiscal 2020 net income of ~$2.25 billion (its target was $1.6-$2 billion in May and $2.7-$3.1 billion before that). Worldwide sales of agriculture and turf equipment are expected to fall 10% and construction and forestry equipment are expected to drop 25% on the fiscal year. Caterpillar, on the other hand, has yet to reinstate financial guidance after withdrawing it during the depths of the COVID-19 crisis.
Deere’s financing arm, John Deere Capital Corp, is expected to face pressure due to “a higher provision for credit losses and less-favorable financing spreads.” Deere’s cash and marketable securities position stood at $8.8 billion combined at the end of its fiscal third quarter, but its total long-term and short-term borrowings are huge at $43.1 billion. Deere has more debt than we would like, but it holds investment-grade credit ratings of A/A2/A from Fitch/Moody’s/Standard & Poor’s.
Cat or Deere?
The fact that Caterpillar is a Dividend Aristocrat speaks to an executive bench that knows how to prepare for the magnitude and duration of any economic cycle. We don’t like the more intensive cyclical swings of Caterpillar relative to Deere, and the size of the debt held by its financing arm makes it comparatively less attractive than some of our top ideas in the newsletter portfolios-- but perhaps its leverage is not as bad as Deere’s. Caterpillar has significant competitive advantages, including a sprawling dealer network, something we like a lot and that garners it moaty characteristics.
Deere is in a better position than Caterpillar, in our view, and both its operating results and share price action reveal as much. The company is not as cyclical as its earth-moving equipment-making counterpart, but it still retains a more leveraged financing arm that creates increased risk relative to other entities that aren’t selling high-priced goods in need of customer financing. Deere has increased its dividend an impressive 170%+ since 2010, so we think management may be as committed as Caterpillar to the payout, though we note it paused its yearly increases during the 2015-2018 period.
Both Cat and Deere are facing some difficult times as COVID-19 continues to spread around the globe. From an operational standpoint, Deere is doing relatively better, but Caterpillar may have a more conservative balance sheet in light of its greater cyclical tendencies.
We have a hard time defending Deere's big share-price run in the face of definitively weaker performance across cyclical end markets, however. Unlike secular players, a falling discount rate won’t have as great of an impact on underlying intrinsic value.
Caterpillar is more reasonably priced, in our view, but then again, the stock comes with a bit more operational risk. We have a difficult time pulling the trigger on either at the moment, especially in the context of so many other net cash rich, free cash flow generating powerhouses tied to secular tailwinds on the market today.
Perhaps the answer is neither. We like our best ideas.
Related: CMC, NUE, AA, VMC, MLM, SUM, USCR, J, GVA, FLR, ARKQ, TKR, HEES, CNHI, AGCO, ETN
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Brian Nelson owns shares in SPY, SCHG, DIA, VOT, and QQQ. Some of the other securities written about in this article may be included in Valuentum's simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.
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