This Global Equipment Maker Has Room to Run In 2014

While this major equipment maker was hit hard by the global slowdown, there could be signs of a recovery that lead to an impressive 2014.

Mar 4, 2014 at 3:15PM

The new year is well under way and one of the best ways to investment in 2014 might be in sectors and companies that have underperformed in 2013. One sector that has been particularly weak is the mining and power equipment sector. Over the last few years, the mining boom came to a screeching halt as activity in China, the U.S., and Europe contracted.

The sector could be close to bottoming and global growth is rebounding, being driven by the North American market. The International Monetary Fund believes that global growth will rise by 3.7% this year and 4% in 2015. Compare this to the less than 3% global growth rate in 2013. The best way to play a rebound in the mining sector, taking into account global growth, is with none other than Caterpillar (NYSE:CAT).

Why 2014 will be a turnaround year for Caterpillar
Shares of Caterpillar underperformed in 2013 and are down 6% over the past year. However, things should turn around for the company in 2014 on the back of a strengthening global recovery, cost reductions and share buybacks. All of which should propel shares of Caterpillar higher over the next 12-18 months.

One country that is dependent on the mining sector is Australia. This area of the market is starting to see a turnaround as several projects that were on the backburner are now going forward. The A$10 billion Roy Hill iron ore project in Australia just received financing from the Export-Import Bank. Caterpillar expects $500 million in fresh sales due to the start-up of the Roy Hill project. Although this will only move the needle slightly for Caterpillar, as it makes up less than 1% of sales, it is a move in the right direction. More projects are likely to get the green light as well. 

The other big driver for Caterpillar is Canadian oil sands. Caterpillar is teaming up with Royal Dutch Shell to run its mining trucks on liquefied natural gas instead of diesel fuel. The goal is to lower fuel costs and reduce emissions, which is a point voiced by critics of the Canadian oil sands projects.

Besides mining and oil sands, infrastructure spending really needs to pick up in the U.S., which would be a big positive for Caterpillar. In particular, there is a push in Congress for more money to repair roads and bridges. Transportation America notes that "1 in 9 US bridges -- about 66,500 in total -- are rated structurally deficient and in urgent need of repairs, maintenance or even replacement."

Other ways to play the infrastructure boom
Among its major peers, Deere (NYSE:DE) and Cummins, Caterpillar offers investors the highest dividend yield. Caterpillar is paying out a 2.6% dividend yield, while Deere's is 2.3% and Cummins' 1.95%. As far as valuation goes, Deere is the cheapest, with a 9.5 times price to earnings multiple. Caterpillar's trades at 16 times earnings and Cummins 17 times.

However, Deere and Cummins could perform well in their respective markets in 2014. Deere has exposure to the agricultural market, which is being fueled by a growing population. While over three-quarters of Deere's revenues are derived from agricultural equipment sales, the company sees a big opportunity for water irrigation systems. Most of the developing countries in the world lack low-cost, efficient, irrigation systems. Recently, Deere partnered with Bank of America to pursue strategic options for its irrigation segment; hoping to take advantage of fact that the global sprinkler market will hit $2.4 billion by 2017.  

As for Cummins, the company is a major engine manufacturer. The company is getting out in front of the move toward a cleaner environment. Cummins has partnered with Westport Innovations to produce an engine for alternative fuel.

Just as Caterpillar is recognizing the move toward natural gas, so is Cummins. And it's already yielding results. For the third quarter, the shipment of Cummins and Westport engines were up 50% year over year. What should further drive Cummins sales of alternative fuel engines is the buildout of natural gas refueling stations.

Bottom line
Caterpillar has been reducing costs and overhead via plant closings and switching its plants over to liquid natural gas for power. All in all, the economic downturn has forced Caterpillar to become a leaner organization. Last year, the company closed plants in Canada, South Carolina, Texas, West Virginia, Minnesota, and Virginia to reduce overhead and trim costs. These were all smaller plants and Caterpillar was able to transfer production to other plants within the system.

This should promote gross margin and operating margin expansion over the next few quarters. On the top line, Caterpillar should get a positive boost from a renewed interest in infrastructure spending. All in all, 2014 should prove to be a great year for Caterpillar, and investors will get a 2.6% dividend yield along the way.

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Marshall Hargrave has no position in any stocks mentioned. The Motley Fool recommends Cummins. The Motley Fool owns shares of Cummins. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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