Caterpillar Earnings: Our Long-Term Thesis Remains Unchanged Amid Declining Orders

The market sent Caterpillar’s CAT shares down approximately 6% in intraday trading on Oct. 31, following third-quarter earnings. The key headline coming out of earnings was the company’s declining order backlog. Caterpillar reported orders decreased $2.6 billion in the third quarter versus last quarter.

At first glance, the backlog update paints a story that long-term growth is breaking down. However, management put current backlog levels into perspective by highlighting the data point remains above historical levels. On a percentage of sales basis, backlog currently sits at 44%, according to management. This compares with 37% in 2017 and 32% in 2018. To us, this implies Caterpillar’s backlog still has some room to reach more normalized levels. Easing supply chain constraints have cut lead times down, giving dealers little reason to overbuy. Furthermore, in construction, excavator inventories remain at high levels, pushing dealers to hold off on new purchases.

We elected to raise our fair value estimate to $229 from $223 previously. Our stronger 2023 sales and margin outlook and tweaks to our long-term forecast, in addition to the time value of money, all contributed to our fair value estimate increase.

Machinery sales increased to $15.9 billion, up 12% year on year. Caterpillar continues to benefit from strong demand across most of its end markets, except for Latin America, which experienced lower sales volume in the construction segment. Operating margins (excluding financial services) expanded approximately 520 basis points to 21.2% in the third quarter, primarily due to strong price realization.

All in all, we aren’t discouraged by normalizing order backlogs. In fact, we remain grounded in our view that Caterpillar will benefit from secular tailwinds. However, we’d like to see a margin of safety in the stock before getting excited about valuation. We view Caterpillar’s shares as fairly valued.