Why 2 Giant Industrial Stocks Dropped Like a Rock Friday

The stock market had another tough day on Friday as investors responded to the failure of another sizable U.S. bank. The Nasdaq Composite (^IXIC -0.18%) was the big loser once again, but declines for the Dow Jones Industrial Average (^DJI -0.51%) and S&P 500 (^GSPC -0.27%) amounted to more than 1%.

Data source: Yahoo! Finance.

With questions arising about the stability of the financial system, it wasn't a big surprise to see weakness in the banking sector. Yet what did come as a shock to some was that industrial giants Caterpillar (CAT -0.87%) and Deere (DE -0.19%) were both down as well. The moves lower show that availability of capital is something that matters not just among financial stocks but across the economy, and it shows that there can be exposure in places many investors wouldn't expect to see it.

Caterpillar gets a downgrade

Shares of Caterpillar fell 6% on Friday. The maker of heavy construction equipment got negative comments from Wall Street analysts, albeit with only modest expectations for share-price declines from current levels.

Analysts at UBS downgraded shares of Caterpillar from neutral to sell. They also reduced their share price target by $5 to $225 per share. The analysts believe that shareholders aren't fully appreciating the likelihood of a cyclical downturn that could hurt revenue and earnings going forward, particularly given that backlog levels aren't growing as fast as they have been recently.

The day's decline brought Caterpillar's stock price to $227, just above the revised price target UBS set. Therefore, it's unclear whether analysts would expect the story ahead to justify a further drop in the stock, even if a sell rating would normally imply that expectation.

Caterpillar combines a sizable dividend with growth potential going forward, and in the long run, few doubt the construction equipment manufacturer's ability to excel. However, that doesn't make the business immune from economic problems, and that's a big part of why the stock dropped today.

Are investors worried about credit?

However, there was another facet to the decline in Caterpillar, and it helps explain why rival Deere was also sharply lower. The farm equipment specialist matched Caterpillar's 6% stock decline.

Both Caterpillar and Deere have financial arms that assist customers and dealers with financing options for equipment purchases. The equipment that the two companies sell is expensive, and so it's typical for customers to need viable ways to pay off their purchases over time.

Cat Financial posted a profit of $535 million in 2022 on revenue of $2.73 billion, making a significant contribution to Caterpillar's overall earnings. Similarly, Deere's financial services segment made an $880 million contribution to net income, which was between 12% and 13% of Deere's overall net income for fiscal 2022.

Liquidity is an important aspect of financing operations, and if the banking environment leads to less liquidity in the financial system, it could eventually pose challenges for the financing arms of Deere and Caterpillar. Add to that the general nervousness about the state of the consumer and business economy and the potential impact on purchases of big-ticket heavy equipment in 2023, and it's natural to see some concern about the near-term prospects for these two stocks.

Few market participants believe that a systemic shock of the magnitude of the financial crisis in 2008 and 2009 lies ahead. However, even a smaller disruption could be enough to show up in the results of some companies that many might think wouldn't have exposure to it.