Stock of the week - Caterpillar

• Blue Wave has arrived following Georgia Senate run-offs

• Cyclicals rally expectations of big infrastructure spending

• Caterpillar's earnings expected to grow 30% in 2021

• Shares reached record high on Wednesday

'Blue Wave' in US politics has arrived. Joe Biden will be sworn-in later during the month and outcome of Senate run-off elections in Georgia means that Democrats will also control the Congress. This will make it much easier for Biden to deliver on his big infrastructure spending promise and Caterpillar (CAT.US) is one of the stocks that would benefit.

Biden promised massive infrastructure spending

Joe Biden promised massive infrastructure spending during his presidential campaign as a way to lift the US economy from depression and put it back on the growth track. What is promised and what is delivered are of course to different things when it comes to politics, especially with divided Congress. However, Democrats managed to flip two Senate seats in Georgia run-off races earlier this week and will have control over both the House and the Senate. This has greatly increased the possibility of adopting a massive infrastructure plan. Manufacturers of machinery like Caterpillar (CAT.US) often benefit at times of increased government spending on infrastructure and stock market anticipates this time will be no different - share price of Caterpillar jumped 5.5% on Wednesday and reached record high.

2021 expected to be turnaround year for Caterpillar

Construction is expected to rebound in 2021 not only because of new government infrastructure spending plans but also because the world will slowly return to normality thanks to vaccination. Caterpillar experienced a 25% YoY decline in revenue in Q1-Q3 2020 combined and almost 50% decline in earnings per share. A more or less similar drop is expected for the final quarter of 2020 (earnings release on January 29, 2021). However, according to Bloomberg, earnings in the first quarter of 2021 are expected to be flat year-over-year and significantly higher in quarters afterwards. Full-2021 earnings are seen almost 30% higher than 2020 results should the median estimates turn out to be spot-on.

Earnings of Caterpillar are expected to start rebounding in 2021. However, even if predictions turned out to be spot-on, earnings will not recover to pre-2020 levels. Source: Bloomberg

Valuation

Share price of Caterpillar dropped around 40% in the aftermath of the 2020 coronavirus panic. However, stock launched a steady upward move off March low and has managed to gain over 120% since. Such a steep price gain combined with lower earnings has left Caterpillar at earnings multiple of 27.44, very high in historical terms. However, comparisons to historical values may not be adequate as current market valuations reflect expectations of a long period of low interest rates. Looking for a better comparison we can just say thatCaterpillar has a lower P/E than the S&P 500 index (29.9) or S&P 500 Industrials Sector sub-index (36.7).

Caterpillar (CAT.US) has been trading in a steep upward channel since the beginning of Q2 2020. Shares rallied yesterday and reached a topside resistance of the channel. Caterpillar is trading at a record high as investors bet Biden's infrastructure plan will help revive earnings following a drop in 2020. Source: xStation5