Caterpillar Inc. released an earnings outlook last week that news service MarketWatch called "the gloomiest so far this earnings season" – and yet investors pushed the shares to a 52-week high, and some of their highest price-to-earnings multiples in years.
This particular halo is extending to the two Canadian companies whose fortunes are lashed to Caterpillar's ship. Finning International Inc. and Toromont Industries Inc., two equipment dealers that get much or nearly all of their revenue from the sale or rental of Caterpillar equipment and parts, are also near 52-week highs, trading at multiples they haven't seen in years.
Investors, it seems, are paying up for a heavy-equipment rebound that simply hasn't happened yet, which should give the owners of these two stocks a pause. However, there's a case to be made that Toromont's investors have a lot less to be worried about than Finning's.
First, let's look to the Caterpillar announcement on July 26. Although the company beat expectations for the second quarter, it revised its full-year outlook downward and said the economic backdrop is, to be polite, not improving as much as the company expected.
Analyst Ben Cherniavsky of Raymond James Canada notes that in last year's second-quarter results, Caterpillar reported "in-line" earnings per share of $1.40 and the stock fell to $76.10 from $79.76.
This year, the company reported second-quarter EPS of $1.09, and the stock rose to $83.38 from $78.79.
The forecast for full-year 2016 EPS a year ago was $5.10, Mr. Cherniavsky notes; Caterpillar is now saying 2016 EPS will be more like $3.50. He says this implies a forward P/E ratio today of 23.5, compared with 16.5 last year.
According to S&P Global Market Intelligence, Finning and Toromont, at forward P/Es of 18.7, are at their highest multiples since 2011. And that's muting analyst enthusiasm for the names, with just two of 10 Finning analysts, and three of nine Toromont analysts, rating the stocks a buy.
However, it's Finning, with the lesser analyst sentiment, as two analysts have "sell" ratings on the shares, compared with none for Toromont.
Vancouver-based Finning, the world's largest Caterpillar dealer, sells the equipment in Western Canada, Britain and Ireland, and in the southern part of South America. That geographic footprint and a big part of its customer base – oil sands operators and miners – has exposed it to the energy downturn and the Alberta wildfires, as well as the concerns about the impact of Brexit on the British economy, note Maxim Sytchev of National Bank Financial and Jacob Bout of CIBC World Markets Inc., the two analysts with sell ratings.
Mr. Sytchev writes that he's not a "perma-bear" on the name, but simply seeks "a better entry point, given macro uncertainty."
He says Finning management "has done a fine job in mitigating the downturn" with its cost-cutting, but he believes Finning's earnings rebound will arrive later than most other analysts do.
Toromont, by contrast, supplements (and diversifies) its Caterpillar sales with an agricultural-equipment business, and garners more than 90 per cent of its sales from Canada.
The company primarily serves Ontario, Manitoba and Eastern Canada, meaning that the British vote to leave the European Union and the wildfires have little or no impact, Mr. Bout notes. (That was evident in its second-quarter earnings released last week, where the company posted a 5-per-cent sales gain. Finning releases results on Wednesday.)
While Mr. Sytchev has an "underperform" on Finning, he has an "outperform" rating on Toromont and a $42 target price that the stock, which closed at $39.20 Friday, has steadily crept up on).
He says the company will benefit from provincial infrastructure spending in Ontario, and its mining customers are skewed toward gold, the metal with the remarkable recent upswing.
More broadly, Toromont has a track record of return on equity, or ROE, figures at the 20-per-cent level, versus Finning's 10 per cent, and an "exceptionally strong" balance sheet.
Toromont's valuation "does not scream value," Mr. Sytchev says, but when he ran the numbers in early July, its 17.3 P/E was just 1.6 points above the broader TSX, at 15.7.
Toromont's expected 2017 ROE of 18.4 per cent against the Toronto Stock Exchange average of 10.6 per cent means the stock "does appear like a much more attractive deal."
He adds: "Given the paucity of long industrial ideas in Canada that have a macro tailwind, we believe [Toromont] shares should be trading at a much more meaningful premium."
It helps explain how Toromont commands the multiple it does when the Caterpillar outlook is so sour.
Finning's popularity is a bit more difficult to explain – and investors would be wise to consider the mystery.
Caterpillar (CAT)
Close: $81.95 (U.S.), down 81¢
David Milstead