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Late last year, when just about every investor was looking for ways to play the hurricane reconstruction efforts in the United States, Citigroup Inc. went sour on the construction equipment sector, downgrading a handful of stocks. Now, with many of last year's supply-chain problems fixed, Citigroup analysts are turning bullish once more.
In a report released last week, Citigroup analyst David Raso said demand in the sector is still far ahead of supply, despite another round of price increases at the beginning of this year.
"While the trick for any cycle is figuring out a quarter or so early when supply will catch demand (as the subsequent overshoot sets up downturn on production cuts), we see many quarters of production headroom before it does," Mr. Raso said.
Citigroup's global survey of construction equipment companies for the fourth quarter of 2005 showed some encouraging trends, Mr. Raso said. Particularly, he pointed to the price of steel and post-hurricane delivery disruptions as two supply-chain issues from last year that have somewhat stabilized.
As a result, Mr. Raso upgraded Caterpillar Inc. from a "hold" to a "buy." He also raised his price target for Deere & Co. and Terex Corp.
On Sept. 26, 2005, Citigroup downgraded a number of construction equipment stocks, including Caterpillar, citing a disconnect between post-Katrina investor enthusiasm for the sector and numerous supply-chain problems. Caterpillar went on to record an earnings shortfall for the third quarter.
However, since then the stock has regained its strength, rising above the price it was at before the third-quarter selloff.
"This highlights to us that as long as 'the cycle story,' i.e., sales momentum is alive, investors will likely come back to Caterpillar assuming earnings will come through enough for the stock to work," Mr. Raso said. "Margin improvement would be the real icing on the cake."
Mr. Raso's price target for Terex was already above consensus before he raised it again last week. The same mining and commodities plays that may prove a boost for Caterpillar may also move Terex's stock, he added, with the price of oil, gold and other commodities rising again.
Mr. Raso also raised his price target for Deere, entirely as a result of the company's construction equipment business, rather than its farm products. Since construction made up only 22 per cent of 2005 sales and 33 per cent of operating profits, changes to the construction forecasts don't alter total company estimates as much as for Caterpillar and Terex, he added.
Caterpillar ended yesterday down $1.73 to $60.78 (U.S.). Deere fell $1.61 to $68.86, while Terex shares rose 26 cents to $64.83. Over the past 12 months, Terex shares are up 50.1 per cent, while Caterpillar is up 35 per cent. Deere shares are almost unchanged over the same time period.
© The Globe and Mail
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