Industrial production improved 0.9% in October as normal operations resumed after Hurricanes Harvey and Irma hampered production in the last two months. Manufacturing output, which accounts for around 75% of total industrial production, increased 1.3%.
With modest upward revisions for July through September, industrial production is now estimated to have only edged down 0.3% at an annual rate in the third quarter. The previously published estimate reflected a 1.5% decline. Total industrial production has risen 2.9% in the past 12 months.
As 95.8% S&P 500 participants in the Industrial Products sector have reported so far, the verdict for third quarter is almost out. These companies have reported 16.7% earnings growth in the quarter. Taking into account the rest of the companies that are yet to report, earnings are expected to grow 18.7% in the quarter, almost in line with second-quarter’s earnings growth of 18.8%.
Per our projections, the Industrial Products sector’s earnings are expected to further accelerate in the fourth quarter with 20.5% growth. Earnings are anticipated to grow 12.1% in first-quarter 2018, 12.8% in the second quarter and 9.7% in third-quarter 2018. (Read more: Plenty of Positive Retail Surprises)
We note that the sector is currently placed at the top 25% out of the 16 Zacks Sectors. (To learn more visit: About Zacks Sector Rank).
This sector has also been outperforming the S&P 500 market in recent times. Year to date, the sector has gained around 18.3%, above the S&P 500 Index’s growth of 16.9%. The sector has particularly exhibited strength following the election of President Donald Trump, primarily due to his promised pro-growth policies. Government policies encouraging better trade relations, increase in infrastructural investments, job creation and high consumer-end demand are likely to accelerate growth of the U.S. economy.
In this context, we put the spotlight on two industrial bigwigs, Caterpillar Inc. CAT and Deere & Company DE. Caterpillar, with a market capitalization of $81.74 billion, is the world's largest manufacturer of construction and mining equipment and also dabbles in agricultural equipment. Deere, with a market capitalization of $46.75 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 both currently flaunt a Zacks Rank #1 (Strong Buy), it will be interesting 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.
Other top-ranked industrial stocks from the sector include The Manitowoc Company Inc. MTW and Terex Corp. TEX. Both the stocks sport a Zacks Rank #1.
Manitowoc has an average positive earnings surprise history of 139.1% in the trailing four quarters. Its shares have soared 73% in the past year. Terex generated four outstanding beats over the trailing four quarters, for an outstanding average positive surprise of 135.9%. Terex shares have rallied 53% in the past year.
Caterpillar Beats on the Bourses
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Year to date, both Caterpillar and Deere have surpassed S&P 500’s performance of 16.9% considerably as well as the overall sector’s climb of 20.2%. However, Caterpillar price gain of 49.9% has outshined Deere’s rise of 45%.
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 have EV/EBITDA ratios of 12.58 and 13.4, respectively. Both are underpriced compared with the sector’s EV/EBITDA ratio of 15.92. Clearly, Caterpillar is the cheaper proposition in comparison.
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 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 inventories. In the last year, the inventory turnover ratio for Caterpillar and Deere has been 3.19% and 4.91%, respectively. While Caterpillar has fallen behind the sector’s inventory turnover ratio of 4.86%, Deere has scored better. Deere is a clear winner in this round.
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. Although they have a comparatively low level of net profit, an above-average ROA denotes that the company in question is generating earnings by effectively managing assets.
A positive ROA indicates that the company has reported gains from assets for the period in question. Coming to Caterpillar and Deere, ROA for the trailing 12-months is 4.25% and 3.53%, respectively, which are below the industrial sector’s level of 5.69%. This round easily goes to Caterpillar.
Dividend Yield
In a year, the dividend yield for Caterpillar has been higher than both the broader sector and Deere. While the broader sector offered a yield of 1.69%, Caterpillar returned 2.25%. In comparison, Deere has a dividend yield of 1.61%.
Leverage Ratio
Deere has a total debt-to-capital ratio of 81.38% much higher than Caterpillar’s 69.59%. Both have higher leverage than the industry’s level of 46.83%. Consequently, Caterpillar fares better on this front.
Last Reported Quarter Performance and Projections
Caterpillar delivered an impressive third-quarter 2017 with adjusted earnings per share not only surging 129% year over year to $1.95 and beat the Zacks Consensus Estimate by a wide margin of 60%.
The better-than-expected performance was due to strong demand for construction equipment in North America, robust sales in China as well as improvement in other markets and disciplined cost-control efforts. Caterpillar expects revenues in the range of $42-$44 billion and earnings per share of $6.25 for fiscal 2017. (Read More: Caterpillar Surges on Q3 Earnings Beat & Guidance Hike)
Deere’s second-quarter fiscal 2017 earnings surged around 74% year over year to $1.57 per share, a positive earnings surprise of 8%. The company’s strong results were driven by improving markets for farm and construction equipment.
Performance benefits from advanced products and flexible cost structure also drove growth. Deere projects total equipment sales to increase about 22% year over year in 2018 and projects net income of about $2.6 billion for the fiscal. (Read more: Deere Tops Q4 Earnings & Sales on Rising Farm Market)
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 53.06%, better than Deere’s average beat of 19.5%.
Earnings ESP: When considering Earnings ESP, Deere has a better chance of delivering an earnings beat next quarter. This is because a stock needs to have both a positive Earnings ESP and a Zacks Rank #1 (Strong Buy), 2 (Buy) or at least 3 (Hold) for this to happen. Deere scores on this front as it sports a Zacks Rank #1 and an Earnings ESP of 4.34%, as the Zacks Consensus Estimate is higher than the Most Accurate Estimate of $1.04.
Meanwhile, Caterpillar has an Earnings ESP of 0.00% as the Zacks Consensus Estimate is in line with the Most Accurate Estimate of $1.69. Caterpillar’s Zacks Rank #1 and Earnings ESP of 0.00%, makes surprise prediction difficult. You can uncover the best stocks to buy or sell before they’re reported with our Earnings ESP Filter.
Earnings Projections: The Zacks Consensus Estimate for Caterpillar for the current quarter is pegged at $1.69, reflecting an impressive year-over-year growth of 103.31%. The earnings estimate for Deere for the current quarter is pegged at $1.04, depicting a 70.7% year-over-year rise.
Growth Prospects
Both have witnessed strong order activity lately. Improvement in construction and cost cutting will drive margins for both the companies. The construction industry has now entered a more mature phase of expansion, and construction spending can be anticipated to see moderate gains through 2017 and beyond. Lately, both the companies' share price has benefited from the victory of President Trump as investors expect his plans of big spending in infrastructure would help boost revenues.
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 8.0%.
Conclusion
Our comparative analysis shows that Caterpillar holds an edge over Deere when considering share price performance, valuation, ROA, dividend yield and long-term growth expectations. Deere scores on inventory turnover and on the prospect of an earnings beat next quarter.
On comparison, Caterpillar is clearly a better stock as of now.
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