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Deutsche Bank Is Cautious On U.S. Machinery, But Loves Caterpillar

Although the US Machinery group has probably hit rock bottom, there is no recovery in sight, Deutsche Bank’s Nicole DeBlase said in a report. There is likely to be only low-single digit organic growth in the natural resource markets through 2020. Against this backdrop, the analyst recommends investing in companies that can grow EPS independent of volumes.

DeBlase initiated coverage of the US Machinery group with a cautious view, while identifying Caterpillar Inc. CAT as the top pick. She added that 64 percent of the company’s revenue seems to have reached a bottom, and there is “scope for a positive inflection in mining A/M, well servicing, and Brazil construction in 2017e.”

Restructuring Payback

Although there is likely to be only 4 percent organic growth in volume in 2017, Deutsche Bank’s EPS estimate for Caterpillar is at $4.03, which is 13 percent higher than the consensus expectation. DeBlase believes the Street is underestimating cost cutting benefits.

Management has spent $2.25 billion on restructuring between 2013 and 2016, and has indicated that the cuts have been “structural rather than temporary,” DeBlase mentioned. Therefore, even with modest volume growth, Caterpillar could generate 15 percent y/y EPS growth, “driven predominately by a narrowing loss within Resource driven entirely by restructuring payback.”

The analyst added that once recovery takes shape, Caterpillar’s incremental margins may expand to 30 percent, from 23 percent in 2010-2012. She initiated coverage of the company with a Buy rating and a price target of $98.

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