The fourth-quarter verdict for the Industrial Products sector is out, with all the S&P 500 participants having reported their numbers. The sector’s impressive 34.8% earnings growth made it one of the nine Zacks Sectors to deliver double-digit growth in earnings. This momentum is expected to continue in 2018 as well. Per our projections, the Industrial Products sector’s earnings are anticipated to register 23.7% growth in first-quarter 2018 followed by 22.8% in the second quarter, 17.7% in the third quarter and 15% in the fourth quarter. (Read more: A Very Positive Earnings Picture)
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Zacks Investment Research
We note that the sector is currently placed at the top 13% out of the total 16 Zacks Sectors. (To learn more visit: About Zacks Sector Rank).
In this context, we narrow the focus on two industrial bigwigs, Caterpillar Inc. (NYSE:CAT) and Deere & Company (NYSE:DE) . Caterpillar, with a market capitalization of $91.8 billion, is the world's largest manufacturer of construction and mining equipment and also dabbles in agricultural equipment. Deere, with a market capitalization of $52.1 billion, is the one of the world's foremost producers of agricultural equipment as well as a leading manufacturer of construction, forestry, and commercial and consumer equipment.
While Deere currently boasts a Zacks Rank #1 (Strong Buy), Caterpillar carries a Zacks Rank #2 (Buy). We pit these two players against each other on certain metrics to see which stock is better positioned in terms of fundamentals. You can see the complete list of today’s Zacks #1 Rank stocks here.
Price Performance
Over the last year, the two stocks under consideration have significantly outpaced S&P 500’s performance of 21.4%. While the Industrial Products sector has advanced 15.2%, Caterpillar has soared 66.4%. Meanwhile, Deere’s shares have also performed better than the sector, with a price appreciation of 46.5%. However, Deere’s gain failed to match Caterpillar.
Valuation
The most appropriate ratio to evaluate these two industrials stocks is EV/EBITDA. This metric is usually used to compare two stocks within the same industry or sector. It is superior to other metrics such as P/E because it is not affected by the different capital structures of the two companies. Further, EV/EBITDA does not include the impact of non-cash expenses.
Both Caterpillar and Deere are underpriced, with EV/EBITDA ratios of 10.1 and 12.2, respectively, compared with the Industrial Products Sector’s EV/EBITDA ratio of 14.4. Clearly, Caterpillar is cheaper and scores on this front.
Inventory Turnover Ratio
Inventory turnover ratio evaluates the efficiency of an industrial company’s manufacturing process. A high inventory turnover ratio ensures that the company is able to manage its inventory effectively to generate revenues and avoid wastage. This is one of the most important financial ratios, which is widely used by industrial companies to measure their ability to utilize their inventories.
In the last year, the inventory turnover ratio for Caterpillar and Deere has been 3.2% and 4.4%, respectively, lower than the sector’s level of 4.8%. Deere has registered better inventory turnover than its competitor.
Return on Assets
Return on assets (“ROA”) is one of the key financial ratios for industrials as they rely heavily on inventory to create revenues. An above-average ROA denotes that the company in question is generating earnings by effectively managing its assets.
Coming to Caterpillar and Deere, ROA for the trailing 12-months (“TTM”) is 5.3% and 3.8%, respectively, which are below the industrial sector’s level of 5.8%. This round easily goes to Caterpillar.
Dividend Yield
Over a year’s time, the dividend yield for Caterpillar has been higher than both the broader sector and Deere. While the broader sector offered a yield of 1.6%, Caterpillar returned 2.0%. In comparison, Deere has a dividend yield of 1.5%.
Net Margins
Comparing the net margin trends of the two companies, Caterpillar has a trailing 12-months net margin of 9.0%, higher than the sector’s 8.3%. Deere falls behind both Caterpillar and the sector with a trailing 12-months net margin of 7.7%.
Last Reported Quarter Performance, Guidance
Caterpillar delivered an impressive surge of 160% year over year in its fourth-quarter 2017 (ended Dec 31 2017) adjusted earnings per share to $2.16. Earnings also surpassed the Zacks Consensus Estimate by a margin of 22%. The better-than-expected performance was due to improved end-user demand and disciplined cost-control efforts.
Driven by strong order rates, lean dealer inventories, increasing backlog and expectation of higher sales volume, the company has initiated fiscal 2018 earnings per guidance range of $8.25-$9.25. This reflects a 27% year-over-year rise at the mid-point reflecting higher sales volume across its three primary segments. (Read more: Caterpillar Gains on Q4 Earnings Beat, Upbeat '18 View)
Deere's first-quarter fiscal 2018 (ended Jan 28, 2018) earnings soared around 111% year over year to $1.31 per share, a positive earnings surprise of 13%. Results were driven by improvement in agricultural and construction equipment markets.
For fiscal 2018, Deere expects net sales to increase about 25% year over year adjusted net income to be about $2.85 billion (excluding the impact of the tax reform). (Read more: Deere Q1 Earnings Beat on Rising Demand, View Upbeat)
Earnings Estimate Revisions
The Zacks Consensus Estimates for both Caterpillar and Deere have been revised upward, following their respective earnings releases. The Zacks Consensus Estimate for Caterpillar for both fiscal 2018 and fiscal 2019 has moved up 1%. The Zacks Consensus Estimate for Deere for both fiscal 2018 and fiscal 2019 has surged 17% and 14%, respectively.
Earnings Projections
The Zacks Consensus Estimate for Caterpillar for fiscal 2018 is pegged at $9.14, reflecting a year-over-year growth of 32.85%. The earnings estimate for Deere for the fiscal 2018 is pegged at $9.53, depicting a 42.7% year-over-year rise.
Earnings Surprise History
Considering a more comprehensive earnings history, both Caterpillar and Deere delivered positive surprises in the trailing four quarters. However, Caterpillar stands out with an average positive earnings surprise of 51.6%, better than Deere's average beat of 17.3%.
Long-Term Growth Expectations
In terms of long-term earnings growth expectations, Caterpillar scores above Deere with a projection of 10.3% compared with the latter's 8.2%.
Both the companies have substantially improved business model delivering better-than-expected margin, earnings, and cash flow performance despite a weak mining and agricultural conditions. Efforts to lower costs helped sustain margins. Both have witnessed strong order activity lately. In North America, continued improvement in residential and non-residential construction as well as revival in infrastructure demand will drive revenues. President Trump’s plans of big spending in infrastructure would be a catalyst for both Caterpillar and Deere.
Global economic momentum and increasing commodity prices is restoring miners’ profitability and they are resuming capital spending. This bodes well for demand for Caterpillar’s mining equipment as demand for new equipment also grows with an extension of existing mines. Caterpillar along with other players in the same industry like Terex Corporation (NYSE:TEX) and Komatsu Ltd. (OTC:KMTUY) will benefit from these improving trends in mining.
Conditions in the farm equipment industry are improving as farmers are replacing equipment based on need. Consequently, Deere’s earnings have upside potential. Also, Precision Agriculture initiatives will help the company outpace competitors and deliver margin improvement in the long run.
However, President’s Trump’s plan to impose import duties of 25% on steel could dent margins of both the companies.
Conclusion
These two stocks have grabbed the spotlight with striking performances in their earnings results, estimate revisions as well as surprise history. However, our comparative analysis shows that the scales are currently tipped in Caterpillar’s favor when considering share price performance, valuation, ROA, dividend yield, leverage, net margins and long-term growth expectations. Deere scores on inventory turnover, earnings estimate revisions and projections for fiscal 2018.
On comparison, Caterpillar is clearly a better stock as of now.
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Terex Corporation (TEX): Free Stock Analysis Report
Caterpillar Inc. (CAT): Free Stock Analysis Report
Komatsu Ltd. (KMTUY): Free Stock Analysis Report
Deere & Company (DE): Free Stock Analysis Report
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