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Is It Safe? Caterpillar Gets Ground Down

Caterpillar is suffering during the worst recession in decades, and good news won't follow until economic growth returns.
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TSC Ratings provides exclusive stock, ETF and mutual fund ratings and commentary based on award-winning, proprietary tools. Its "safety first" approach to investing aims to reduce risk while seeking solid outperformance on a total return basis.

The economic recession has devastated


(CAT) - Get Caterpillar Inc. Report

, cutting in half its stock price during the past year.

But the largest U.S. maker of earth-moving equipment has rallied during 2009, jumping 26% over three months. Don't be fooled: The construction slump is in full effect. Only stimulus projects are propping up demand.

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Here's what we know: Caterpillar posted a first-quarter net loss of 19 cents a share. Excluding redundancy costs, the company booked a profit. Revenue fell 22% from a year earlier. Still, net operating cash flow rose 27% to $895 million as Caterpillar made impressive efforts to bolster liquidity. Cash and equivalents quadrupled to $3.56 billion. Debt remained dangerously high at $34.9 billion. The company's debt-to-equity ratio, a measure of leverage, is excessive at 5.6.

To be sure, based on a comparison with peers and its own historical stock price, now's an attractive time to buy Caterpillar. The shares are cheap based on cash flow, earnings and sales. Caterpillar's price-to-earnings ratio is 8.3, and the company's stock offers a dividend yield of 4.4%.

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The Commerce Department yesterday said March construction spending inched up 0.3%, beating the consensus estimate of a 1.6% drop. Non-residential construction, which includes public projects, increased 2%. But residential construction registered a sequential monthly decline of 4.6%.

As stimulus projects ramp up in late 2009 and 2010, Peoria, Ill.-based Caterpillar should see improved orders for equipment. But aside from government projects, business will remain weak. Residential and commercial construction is abysmal. Commercial builders, in particular, are in a state of rapid deterioration.

Vacancies at U.S. malls and shopping centers are at the highest level in 10 years. And

General Growth Properties


, the second-largest U.S. shopping-mall operator, filed for Chapter 11 bankruptcy last month. Commercial building projects are in the doldrums, hurting Caterpillar's revenue.

The company is hoping aggressive cost-cutting will streamline operations. Also, a big exposure to China may fuel a faster-than-expected rebound. Monthly sales of excavators in China topped 600 before the financial meltdown in September and then crashed in the fourth quarter. CEO James Owens reported that China excavator sales are back to record levels for March and April.

Caterpillar has a significantly underfunded pension plan, at 61%, and will be strenuously working to free itself from a heavy debt burden and further improve its cash position during the second quarter. Fitch downgraded Caterpillar's credit rating to "A" from "A-plus" on April 22. TSC Ratings gives Caterpillar a "hold" rating.

Caterpillar issued a mixed 2009 outlook. The company expects to turn a profit, but also forecasts a sales decline of about 32%. It will benefit from domestic and international stimulus projects, particularly in China, but a prolonged U.S. housing and construction downturn remains likely.

Improved pending home sales indicate an economic bottoming, but there is no surge in construction activity in the offing to bolster short-term prospects. As a long-term investment, Caterpillar is attractive. It's cheap and reliable, with a steady dividend. But in our current economic environment, there are stocks with a superior return potential. Don't consider Caterpillar until gross domestic product growth turns positive.