Caterpillar Remains Strong Despite China’s Import Tariffs

Caterpillar Remains Strong Despite China’s Import Tariffs

 
The stock of earth moving equipment manufacturer Caterpillar Inc. (NYSE: CAT) declined to $142 yesterday, before closing at $145. The main reason for the decline is the retaliatory tariffs announced by the Chinese government on 106 US products. However, China’s Ministry of Commerce has not revealed the exact date on which the newly announced import duties to the tune of $50 billion will become effective. Investors are also concerned about a possible impact on Caterpillar by the tariffs levied on steel imports by the US government. Caterpillar buys steel locally and internationally. The company, along with Boeing, represents 14% of the DOW index. Therefore, the market is closely watching those two stocks. However, as explained below, Caterpillar is not going to be affected by the import tariffs and so the stock will bounce back soon.

According to Zacks, “Caterpillar faces headwinds from raw material cost inflation and higher restructuring charges, which expected to weigh on its margins in 2018. The company expects about $400 million of restructuring costs in 2018.”

Caterpillar, while presenting its latest quarterly earnings report, said that it expects FY18 profit of $7.75 to $8.75 per share. Excluding $400 million in restructuring costs, Caterpillar expects earnings in the range of $8.25 to $9.25 per share. So, despite the headwinds, Caterpillar anticipates to perform better this year. The company’s guidance is based on an expected increase in sales volumes across its three main segments, namely Construction, Resource, and Energy & Transportation.   

Zacks had also mentioned that the recent tariffs on steel imports will inflate manufacturing costs of Caterpillar. It should be noted that Canada and Mexico, the major exporters of steel to US, with a market share of 16.7% and 9.4%, respectively, is excluded from the import duties. Furthermore, the Trump admin is also working out a deal to avoid duties on steel imports from Australia. Caterpillar has explained to RTT news that it is still studying the impact of duties on its manufacturing cost. Furthermore, the company expects the boom in the North American construction activity to offset cost increases in 2018. North American construction activity accounts for 46% of the company’s revenues.

According to some research reports, a seasonal sales slowdown in China is expected to impact Caterpillar. We would like to highlight that Caterpillar earns only 5% of its total revenue from China, according to a survey conducted by FactSet. Therefore, a slowdown in China may not affect the company as anticipated.

Additionally, a resurgence in mining activity due to an increase in commodity prices is also expected to boost sales. An increase in oil & gas well servicing activity and a slight improvement in the power generation sector is also expected to offset any decline in sales due to Chinese import tariffs. Finally, the lower tax rate of 24% is also expected to keep the company financially healthy. At the end of December 2017, the company had a backlog of about $15.80 billion, versus $12.10 billion in December 2016. China’s “belt and road” initiative is also expected to act as a catalyst to the sales. Therefore, fundamentally, the stock is expected to bounce back in the short-term.

The stock is trading a notch above the 200-day moving average, which generally acts as a major support. Furthermore, the momentum indicator is making a positive divergence with the stock. Additionally, the stock also has a support at 138. Therefore, we can expect a rally from the current level.

Caterpillar - Technical Analysis - 5th April 2018

In order to gain from the uptrend, we are planning to invest in a call option contract, which is valid until April 13th. Before placing a bet on the call option, we would make sure the stock trades near $143 in the NYSE.

Disclaimer: The trading analysis offered here is our opinion. It is not provided as trading advice, merely an indication of our trading plan. We cannot guarantee success and we encourage traders to incorporate a strong money management strategy to limit losses. Please use this article as part of your own research before formulating strategies prior to trading.


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