Why higher commodity prices are good for Caterpillar

Matt Elkott, equity research analyst at Cowen covering diversified industrials and transportation OEMs, discusses his initiation of Caterpillar, including why he is projecting the industrial’s first megacycle in 14 years.

Video Transcript

BRIAN SOZZI: Is Caterpillar poised to cash in on its first true mega cycle in more than a decade? Our next guest says yes and is out with a very bullish call on the heavy equipment maker. Matt Elkott is an analyst at Cowen that covers industrials and transportation OEMs and joins us now. Matt, good to see you this morning. Top of your note, you come out outperform rating $241 price target calling or highlighting the potential for a mega cycle for Caterpillar. What do you mean by that?

MATT ELKOTT: That's right, Brian. So we're projecting a mega cycle of financial performance for Cat in the next three years starting in 2021, growth in revenue, gross margin, operating margin, and EPS. This is not inconsistent directionally with consensus. We are above consensus by magnitude. Directionally, it's fairly consistent with consensus.

But I think what's somewhat overlooked here, Brian, is that this will be the first time in 14 years that Cat has growth in all these metrics for three consecutive years. The last time this happened 14 years ago, the stock had one of its most sustained positive price action.

JULIE HYMAN: Matt, it's Julie here. Talk to me about the interplay between this thesis and a commodity mega cycle. Obviously, Caterpillar relies for a lot of its revenue on companies that get stuff out of the ground whether it be agricultural goods or metals and the like and other kinds of materials. So is this presupposed on the idea that we will continue to see commodity prices go higher?

MATT ELKOTT: Sure, Julia, this is definitely one part of it. Mining equipment is their third largest segment. They don't do much in ag. In mining, we are having a commodity recovery across the board. We are expecting that to continue but to moderate gradually over time. Commodity prices do raise their input costs. But on the balance, higher commodity prices are good for Cat because their customers do-- do well. And that more than offsets the higher input costs from a rise in-- in commodities. So yes, that is definitely a part of our thesis.

BRIAN SOZZI: Matt, you talk a good bit in the note about autonomous. I mean, how far are we away from seeing autonomous dump trucks? And how big a business is that or could it be for Caterpillar?

MATT ELKOTT: Sure, Brian, they do exist now. Cats had autonomous equipment in mining for quite a few years now. The most recent-- the latest announcement on this front was an agreement with Rio Tinto for 35 autonomous trucks that are also going to be zero emission.

So I think the sweet spot for autonomy and new power technologies going forward will be electrified autonomous vehicles. I do expect that this will be a fast-growing market for the next 10 years. We've actually identified a $35 billion revenue opportunity-- potential revenue opportunity from autonomy alone over the next 10 years. But autonomy will overlap with some power technologies, mainly electrification.

BRIAN SOZZI: Yeah, let's say on the [AUDIO OUT] the engines to electric trains. Where is Caterpillar in that push to turn over or just make its entire fleet electric?

MATT ELKOTT: Brian, you cut out for a bit. Sorry about that. I don't know if it's my internet. Would you please repeat the question?

BRIAN SOZZI: Not a problem. How far away is Caterpillar from electrifying its full fleet of vehicles?

MATT ELKOTT: That's a great question. I think, you know, I think it's hard to-- to say in specific terms, but I think that's going to be the direction going forward. You're going to see a-- an increasingly larger percentage of their equipment being either electric or other alternative fuel technologies or autonomous. And you'll see particular growth in the area that-- where both autonomy and electrification overlap.

And it's not only in their mining equipment or construction equipment. They also have a switch locomotive that's an electric locomotive. They just announced an agreement with Chevron on a hydrogen locomotive. This may be the precursor of a line-haul locomotive that could be the answer to Wab's-- Wabtec's FLXdrive locomotive that they've tested with Burlington Northern.

JULIE HYMAN: And Matt, finally, I want to ask you about the infrastructure bill. You say in your note 33% of the company's total revenues could benefit directly or indirectly from that bill. But boy, that bill is not currently going much of anywhere. So I'm just curious, as you put your sort of politics hat on, whether you think it's still likely this year or even next year at this point.

MATT ELKOTT: You're right. It's been-- there's been some drama on the infrastructure bill front. The infrastructure bill is one of our key underlying assumptions. So if-- if it's botched, or if it's delayed significantly, it would be a risk to our forecast. But either way, they're not going to start seeing the actual dollars from the infrastructure bill, even if it's passed say in this month. They won't start seeing the actual dollars from the infrastructure bill for quite a while.

What will happen, though, is that customers will probably feel a lot more comfortable pulling the trigger on orders when a bill is passed. That's been the trend in the past whenever there was some major legislation on the dock. So you know, whether it will pass or not, I-- you know, that's the opinion of the-- or that's the area of our policy analyst Chris Krueger, who's-- who publishes-- publishes on that. And I believe he thinks it will pass.

BRIAN SOZZI: Well, he's got the fun job there. Matt Elkott, analyst at Cowen with our call of the day on Caterpillar. Thanks so much.