Analysts at UBS have reiterated their ‘Sell’ rating on heavy machinery manufacturer Caterpillar Inc. (NYSE:CAT) after the company’s recent 20% rebound on their belief that a slowdown ahead had not been priced into the company's valuation.
The analysts wrote, while they expected a solid second quarter from Caterpillar, the company will face much tougher year-over-year comparisons in the third quarter as it laps price increases across its business.
“We expect CAT’s growth to slow substantially as it hits much tougher comps in 3Q,” they wrote in a note to clients.
“These tough comps will lower expectations of growth potential, especially in a more variable demand environment, and CAT's stock historically trades with growth.”
They added that they expect volume growth to be pressured by more variable demand, including weakness in China, lower rig counts/oil prices, and macro pressure in parts of Europe and Latin America.
“On price, CAT could try to raise prices again mid-year, but we think it will be challenging to achieve broad price increases amidst more variable demand and tougher competition,” they noted.
“Backlog is poised to roll over; in 1Q, backlog was flat sequentially, which was the first non-positive quarter in three years. We think that 2Q could be the first negative quarter, as dealers normalize their orders due to shorter lead times.”
Further, the analysts said they expect Caterpillar’s margins to face pressure from reduced operating leverage, as the company plans to produce less in 2H than in 1H to manage inventory levels.
Additionally, Caterpillar’s stock has run ahead of copper prices, outperforming them by 10% to 15% in June, which is a “significant divergence” from the normal trend.
“We expect this gap to narrow through underperformance by CAT stock (similar to earlier this year),” they wrote.
“We expect the multiple to compress as investors taper growth expectations, and we think risk-reward skews to the downside.”
Caterpillar shares are currently trading at $247.52. The UBS analysts have a $208 price target reflecting a 12 x P/E on their estimate of 2024 earnings per share of $17.30.
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