Why I'd Stay Away From These Three Heavily Touted Stocks

February 28th, 2014
in contributors

by Mitchell Clark, Profit Confidential

Deutsche Bank just issued new "Buy" ratings on Caterpillar Inc. (CAT), Cummins Inc. (CMI), and Deere & Company (DE), which is quite a bold move.

It's an early call on a sector turnaround. All three of these companies recently announced mediocre fourth-quarter earnings. Deere & Company expects its total sales to decline this year.

Follow up:

Caterpillar really hasn't done anything on the stock market for the last couple of years, and Cummins has actually been kind of volatile on declining trading volume. Cummins is the outperformer among these stocks by a wide margin.

Anytime you get large, industrial equipment manufacturers being upgraded, it postulates a view that global economic growth is about to accelerate.

Whether this happens or not, it's actually very useful to read what Caterpillar, Cummins, and Deere & Company have to say about their businesses. All three companies have tried to keep their earnings elevated in the face of weak or declining top-line growth.

Cummins' largest customer (12% of total sales) is PACCAR Inc. (PCAR), which manufactures "Kenworth" and "Peterbuilt" trucks domestically, and "DAF" trucks for Europe and other international markets.

Cummins' 2013 global sales were down slightly not only from 2012 but also from 2011. Management said that it expects market share gains in North American medium-duty trucks, but domestic and international mining markets as well as foreign currency instability are headwinds for earnings.

Caterpillar recently turned higher on the stock market, but the company's most recent quarter wasn't that great. It beat Wall Street's consensus on revenues and earnings, but total sales were still down comparatively.

There are a lot of reasons why a Wall Street research analyst might come out with a new "buy" rating on a group of companies. But this one seems to be putting the cart before the horse. Recent earnings from these companies were just not that great. An upgrade or new "buy" rating seems premature.

In any case, stocks often do rise on anticipation of future results. And there have been a lot of cases where sell-side research analysts issue "buy" ratings on a company after their share price has already gone up tremendously.

It does seem likely that there will be continued pressure on the earnings results from large equipment manufacturers, especially given that the mining industry continues to experience higher costs with stagnant spot prices. (See "The Stocks to Own Right Now...")

As an industry sector, it's always useful to know what these companies are saying about their businesses and earnings; but for investors, it seems a bit early for potential new buyers to consider these stocks.

With revenue and earnings stagnation among large-cap equipment manufacturers, companies have two ways to keep investors interested: share repurchases and dividend increases.

Balance sheets for these companies are still strong, and the cost of capital is so low for big corporate customers that raising cash is not a difficulty. (New bond issue on the horizon?)

Deutsche Bank thinks there will be a meaningful recovery led by the U.S. and China in the construction and mining industries this year. Whether this transpires or not, it will be a number of quarters before this might translate into better earnings over previous years.

This article Why I'd Stay Away From These Three Heavily Touted Stocks was originally posted at Profit Confidential

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