At the onset of 2016, the industrial machinery sector was one of the most adversely impacted industries in the U.S, reeling from the uncertainties in the global arena. This scenario can be attributed to weak commodity prices, reduced investment in the energy sector as an aftermath of lower oil prices, poor economic conditions in some developed and developing nations and Brexit. However, sentiment steadily improved, thereafter, particularly following the victory of Donald Trump as investors anticipate his plans of big spending in infrastructure, and easing regulations for oil and coal exploration would help boost the industry.
Let’s take a quick look at the industrial products sector’s performance in 2016. Following an unceremonious decline of 21.6% in the first quarter, it has somewhat recovered with a 1.2% dip in the second quarter and then went on to log a 13.7% growth in the third quarter. As per our projections, following a 1.7% dip in fourth quarter, the sector will remain in the positive territory in 2017 with growth of 8.3%, 7.5%, 2%, 12.9% in the first, second, third and fourth quarters of 2017, respectively. (For a detailed look at the earnings outlook for this sector and others, please read our Earnings Trends report.).
The IMF anticipates the world economy to grow 3.4% in 2017, including 1.8% growth for advanced nations and 4.6% improvement for emerging countries. In the quarters ahead, governmental policies encouraging better trade relations, increase in infrastructural investments, job creation and high consumer-end demand will sustain growth for industrial machinery stocks. Until such improvements materialize, stocks with high investment rankings might interest investors seeking exposure in the machinery industry.
The ‘Industrial Products’ sector, is positively placed at 7 out of a total 16 sectors we cover (top 44%). In the sector, two heavyweights that hog the limelight are Caterpillar, Inc. CAT and Deere & Company DE with market capitalizations of $55.4 billion and $33.5 billion, respectively. Caterpillar is the world's largest manufacturer of construction and mining equipment and also dabbles in agricultural equipment, while Deere is the one world's foremost producers of agricultural equipment as well as a leading manufacturer of construction, forestry, and commercial and consumer equipment.
Investors keen on this sector would be inquisitive about which one has the more attractive prospects. Let's look more closely at how Caterpillar and Deere fare on some key metrics to see which stock deserves to be a part of your portfolio.
Caterpillar’s stock has rallied 54.4% in the past one year, outperforming Deere’s gain of 43.6% over the same time frame. Both have outpaced the Zacks categorized Machinery industry’s gain of 42.6% as well as the Industrial Product’s sector’s rise of 39.1%.
From a valuation perspective, the Caterpillar stock, which is trading at a forward P/E multiple of 31 is more expensive than the Deere stock which is trading a multiple of 23.9. Both are trading higher than the industry multiple of 22.
Rank and Subindustry Ranking
Caterpillar currently carries a Zacks Rank #3 (Hold). It falls under the Zacks Categorized Manufacturing-Construction and Mining sub industry which is currently carrying a Rank of #182 (out of 265 industries we cover), being in the bottom 31%.
While, Deere sports a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here. It falls under the Zacks Categorized Manufacturing-Farm Equipment sub industry which is currently carrying a Rank of #165 (out of 265 industries we cover), being in the bottom 38%.
Long Term Growth Expectations
In terms of long-term earnings growth expectations, Deere scores above Caterpillar with a projection of 7.67% compared with the latter’s 4.25%.
For income investors, Caterpillar has a higher dividend yield (3.25%) than Deere (2.27%). Caterpillar last raised its dividend in Jun 2015 and has raised its dividend for consecutive 22 years. Deere has maintained its dividend since 2014.
Despite weak demand, both the companies have managed to beat estimates of late owing to their cost cutting efforts. Caterpillar has beat the Zacks Consensus Estimate in all the last four quarters with an average earnings beat of 8.53%. Deere also has an impressive track record, beating the Zacks Consensus Estimate in all the four quarters, with an average earnings surprise of 58.17%.
Estimate Revisions Trend
For Caterpillar, for fiscal 2016, one estimate has gone down with no upward movement in the last 60 days. For fiscal 2017, there have been nine downward revisions in the same time frame. The Zacks Consensus Estimate for fiscal 2016 has thus edged down 0.3% to $3.24 while the estimate for fiscal 2017 has dipped 10% to $3.03.
On the contrary, for Deere, nine estimates have moved north in the last 60 days with no downward movement. Over the said timeframe, the Zacks Consensus Estimate for Deere has moved up 14% to $4.39 for fiscal 2017 and for fiscal 2018, the estimate has moved up 13% to $5.35.
Results & Growth Prospects
Caterpillar’s financial performance was not worth writing home about in the first three quarters of 2016 as the mining and construction equipment behemoth continues to reel under lower end-user demand. While commodity prices have improved from their recent lows, it is not clear whether it is sufficient to drive increased demand for mining equipment.
Meanwhile, despite a drop in fourth-quarter fiscal 2016 earnings, Deere’s net income of $1.5 billion in fiscal 2016 was the highest in the last ten years. Despite a weak global agricultural sector, the company benefited from the adept execution of its operating plans and disciplined cost management as well as the impact of a broad product portfolio. Deere remains committed to its target to reduce structural costs by $500 million by fiscal 2018.
For both the companies, improvement in construction and cost cutting are the keys to stay profitable. The construction industry has now entered a more mature phase of its expansion, and construction spending can be anticipated to see moderate gains through 2017 and beyond.
Lately, both the companies’ share price has benefitted from the victory of Donald Trump as investors expect his plans of big spending in infrastructure would help boost revenues. Further, investors appreciate their determined efforts to cut costs that will lead to margin expansion as revenues improve under President Trump.
With a favorable Zacks Rank and positive estimate revisions, the scale is tipped in Deere’s favor. A cheaper valuation and higher long-term earnings growth expectation also make Deere a better bet.
Some Other Stocks
Apart from Deere, investors interested in the industrial products sector may also consider Altra Industrial Motion Corp. AIMC and Apogee Enterprises, Inc. APOG, both of which carry the same Zacks Rank as Deere.
Where Do Zacks' Investment Ideas Come From?
You are welcome to download the full, up-to-the-minute list of 220 Zacks Rank #1 "Strong Buy" stocks free of charge. There is no better place to start your own stock search. Plus you can access the full list of must-avoid Zacks Rank #5 "Strong Sells" and other private research. See the stocks free >>
Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free report
To read this article on Zacks.com click here.
Zacks Investment Research