Construction equipment stocks are on a roll. Caterpillar (CAT 0.72%) hit its 52-week high on Monday and Manitowoc (MTW -0.65%) shares zoomed to levels not seen in nearly five years. There were no company-specific announcements or any major economic news; the excitement actually spilled over from last week after Deutsche Bank turned bullish on both stocks and sent them soaring.
But wait, it's a lot more than an analyst upgrade. Good news seems to be pouring in from several sides for Caterpillar and Manitowoc, and investors just can't wait to get a piece of the action. But is the momentum here to stay, or will the two stocks give it all up before it is fully realized? A look at the factors that are bidding the shares up may give you an answer.
On solid ground
The recent uptick in construction activity in the U.S., especially nonresidential construction, is the biggest factor that's fueling optimism in both Caterpillar and Manitowoc. Caterpillar gets about a third of its revenue, and Manitowoc more than half its sales, from that region.
Caterpillar confirmed the strength in domestic markets last week when it released its retail machine sales data: North America was the only market where the company reported a percentage improvement in sales for the quarter ended January. Sales from every other geographic region fell by double-digit percentages. But the market is probably expecting things to turn around.
Hopeful signs, but...
Economic data released earlier this month showed that the six biggest eurozone economies expanded during the quarter through December 2013 -- something we haven't seen in nearly three years. The eurozone crisis has been a major drag on Caterpillar's and Manitowoc's sales for several quarters, so any sign of improvement bodes well. The Europe, Africa, and Middle East region contributes nearly a quarter to revenues of both companies.
In another development last week, China reported record imports of coal and iron ore for the month of January. Caterpillar investors, in particular, got excited since the company is heavily exposed to the mining industry and is betting big on the Chinese market for future growth.
Unfortunately, it may be too early to rejoice. Europe isn't out of the woods yet, and higher ore imports from China do not necessarily mean greater mining activity. In fact, January's manufacturing report out of China was a bummer. Persistent challenging business conditions in the nation even compelled Manitowoc to offload its 50% stake last month in a joint venture set up in 2008 with a Chinese company, after having already exited another venture late last year.
In other words, you may have to wait some more quarters before these markets revive. And until then, neither Caterpillar nor Manitowoc can grow their top and bottom lines as you would want to see.
So, what is Deutsche Bank betting on?
Why did Deutsche Bank initiate coverage on the two stocks last week, rating Manitowoc a hold and Caterpillar a buy with a price target of $122 a share?
For Caterpillar, Deutsche opines that investors shouldn't overlook the growth potential in the company's construction equipment and power-systems businesses even as the mining sector remains weak. That makes sense, but investors should also remember that mining has traditionally been Caterpillar's highest-margin business.
That explains why the company suffered a huge blow on its bottom line last year despite good demand for its construction and power systems machines. Moreover, while Caterpillar expects revenue from the two businesses to improve 5% each in 2014, a projected 10% drop in its mining division could mar growth.
For Manitowoc, a sluggish mining market may not be a major issue, but it runs a parallel business of equipment that caters to the foodservice industry which hasn't been doing too well lately. But the company sprang a surprise last quarter when its food-service equipment division reported strong growth in revenue as well as margins. Manitowoc also sounded optimistic about the business for the rest of the year, which played a huge role in driving its shares up to a multiyear high.
Where are the two stocks headed?
After a super run in 2013, I don't see a reason why Manitowoc shares shouldn't continue to head higher this year. But at 27 times earnings, the stock currently trades at a wide premium compared to most peers, so upside may be limited.
Caterpillar shares, on the other hand, are slowly getting back to their feet after facing a rough 2013. While headwinds remain, the company may have already left the worst behind. The stock may have a bumpy ride ahead, but at 16 times earnings, it's certainly cheap enough to excite long-term investors.