Caterpillar, Deere Proxies for Emerging Markets

BOSTON ( TheStreet) -- Rising food and energy costs in emerging markets could hurt industrial and agriculture companies such as Caterpillar ( CAT) and Deere ( DE). Still, investment managers expect more gains after they report fourth-quarter financial results.

Rapid growth of the developing world has paid off for industrial stocks like Caterpillar, and farming-related names also continue to outperform. While the S&P 500 climbed nearly 12% last year, Caterpillar surged more than 60% and Deere rallied 47%.

Agriculture commodity names, like Archer Daniels Midland, instead have seen increased volatility. Shares slipped nearly 5% last year, underperforming the broader market, although shares are up almost 25% since July.

Each company's fourth-quarter earnings report will shed light on what has been occurring in emerging markets and could set the tone for the entire year. Food scarcity in some countries has lead to a mismatch in supply and demand. Agriculture commodity prices have spiked in response and food price inflation has picked up. Some countries, like China, have begun interest rate hikes in response.

"Qualitatively, investors want to hear about what's happening in China," says Michael Sheldon, chief market strategist with Westport, Conn.-based RDM Financial Group. "Right now, investors want to see growth in emerging markets. Companies like Caterpillar can be seen as a proxy of the rate of growth in emerging markets."

Sheldon notes that Caterpillar made the purchase of Bucyrus ( BUCY) late last year explicitly to gain a stronger foothold in emerging markets.

Farming and agriculture companies are also affected greatly by inflation in emerging markets. Jerry Jordan, manager of the Boston-based Jordan Opportunity Fund ( JORDX), argues that the inflation genie is out of the bottle, and it will be very hard to push it back in.

"The inflation rates in emerging markets are going to remain higher longer," Jordan warns. "There will be rate-increasing risks, too, as in countries tightening too much. I am a huge believer that you should take your emerging-market positions and cut them in half. Markets see trends way out in the distance and they price them in quickly."

Jordan likens the situation to how Internet companies were viewed before the tech bubble burst. Stocks went to valuations that were "totally ludicrous. They may never see those highs." He adds that emerging markets are the growth story, but "they've got a lot of problems. They've got a huge inflation problem. Their currencies are too weak and they ought to be a lot stronger."

As a result of the rising food and energy costs, Sheldon says the market has see profit-taking in many basic material and industrial names, like Caterpillar, given recent outperformance and investor skittishness over the condition of those emerging markets. "Even if a company does record a strong earnings report, we could easily see some profit taking on the news," he says.

Despite all of these concerns and the impact they could have on industrial and agriculture stocks with exposure to emerging markets, investment managers still expect these companies to gain from the heightened demand from emerging middle classes globally.

Jordan estimates that there are up to 800 million people in the middle class in emerging markets. "That's a lot of people," he says, "and it is an enormous difference in demand." The analogy he offers is that agriculture is where natural gas was in 2004.

"It has a minimum of four to five years in front of it," Jordan says. "Agriculture broke out in 2007 and reach supply and demand parity. Then there was the big economic collapse that wiped out demand on the margin. But it didn't change the underlying fundamentals. People didn't stop existing, so they didn't stop eating. And the middle class in a lot of countries has come searching through."

So while Caterpillar, Deere, and Archer Daniels Midland aren't in the same exact market industry, what each company says about emerging markets when they report fourth-quarter results will be significant for investors. On the following pages, TheStreet previews these stocks and what fund managers are looking for in fourth-quarter financial results.

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Caterpillar ( CAT)

Company Profile: Caterpillar

Reporting Date: Jan. 27, before the market opens

Expectations for the Quarter: Caterpillar is expected to book a fourth-quarter profit of $1.27 a share on revenue of $11.6 billion, according to a poll of analysts by Thomson Reuters.

Fund Manager Take: Caterpillar has been firing on all cylinders over the past several quarters and it has beaten earnings and revenue expectations handily over the past year. Investors will be looking for that trend to continue this quarter, says RDM Financial's Sheldon.

"In terms of Caterpillar, most investors realize that the earnings and revenue trends look fairly positive as you look out over the next years," Sheldon says. "Therefore, instead of focusing on the bottom line, there are other things to look for."

Among those items, Sheldon is looking for an update on Caterpillar's merger with Bucyrus. The Department of Justice has recently made a second request for information, and Bucyrus shareholders approved the deal; the company said it expects the deal to close in the middle of 2011.

Because of Caterpillar's emerging market exposure through its engines business, what management says about the coming year will be weighed heavily by investors. And because Caterpillar is a market leader, Sheldon says investors should navigate toward this stock rather than other U.S. competitors.

"As an investor in this part of the market, you want to stay with the market leader," Sheldon says. "Caterpillar has a strong track record of execution in recent quarters and it appears to be the front-runner at this point."

With $650 million in assets under management, RDM Financial doesn't make big bets on stocks or mutual funds. In fact, Caterpillar is one of many equally weighted stocks in the portfolios that RDM owns. Still, Sheldon trumpets Caterpillar's attractiveness from a fundamental valuation perspective.

"As we look ahead to the remainder of 2011 and 2012, Caterpillar is trading at a price-to-earnings estimate of 16.1 times this year's earnings and 12.3 times next year's earnings," Sheldon says, noting that the market has a P/E ratio of 18. "Given the company's growth rate and the end markets in which it operates, we believe that Caterpillar is attractively valued at current levels."

Lastly, Sheldon points out that Caterpillar has a track record of raising its dividend and says it's likely that Caterpillar will raise its dividend sometime this year.

"At one point during the economic downturn, the dividend yield on Caterpillar was above 3%, but that has come down as the stock has performed so strongly," he says. "I'm sure that investors are probably happy to have a strong total return made up more of capital gains than income."

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Deere ( DE)

Company Profile: Deere manufactures farm and turf equipment, including utility tractors, loaders, combines and cotton and sugarcane harvesters. Additionally, Deere has a business segment that produces machines for construction, earthmoving, material handling, and timber harvesting.

Reporting Date: Feb. 14, before the market opens

Expectations for the Quarter: Wall Street expects that Deere will report fiscal first-quarter earnings of 98 cents a share on revenue of $5.7 billion, according to a poll by Thomson Reuters.

Fund Manager Take: Jerry Jordan says that when it comes to earnings season, he doesn't do a lot of in-depth earnings work.

"Our work is much more top-down and, on a quarterly basis, it's more about trying to understand where the numbers can do," he says. "That's opposed to us looking at Street estimates. We don't do that because there is so much noise you can get numbers."

As Deere is a top 5 holding in his $110 million fund, Jordan will certainly still be paying attention to the earnings report, paying particular attention to the guidance management provides.

"Deere is historically conservative with their guidance, so my best guess is that they're not going to be aggressive with first-quarter and 2011 guidance," he says. "They'll be conservative much in the way they were when they reported last quarter."

In November, Deere said it had a fiscal fourth-quarter profit of $1.07 a share on $6.56 billion in sales, blowing past analysts' estimates. On the company's conference call, Deere guided to full-year earnings of $4.90 a share, below the consensus at the time of $5.23 a share.

That could lead to an easy earnings beat in the company's first fiscal quarter of 2011, Jordan says. But regardless of what Deere reports, he still believes the stock is going to continue to grind its way higher.

"It is overbought and expectations are high, and the overall market is a little ahead of itself," Jordan acknowledges. "It could be a situation like Google ( GOOG) and Apple ( AAPL), where terrific numbers are reported and the stock goes down. Could Deere be an $80 stock in two weeks? Absolutely. But there is not a chance it is a $70 stock, unless the Dow drops to 10,000. As a stock, Deere is pretty extended but it's not that expensive."

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Archer Daniels Midland ( ADM)

Company Profile: Archer Daniels Midland transports, stores and processes agricultural commodities, likes oilseeds, corn, wheat and cocoa. The company also manufactures vegetable oil and protein meal, corn sweeteners, flour, biodiesel, ethanol, and other food and feed ingredients.

Reporting Date: Feb. 1, before the market opens

Expectations for the Quarter: Analysts are predicting that Archer Daniels Midland will report a fourth-quarter profit of 79 cents a share and revenue of $17.3 billion, according to a poll conducted by Thomson Reuters.

Fund Manager Take: For Dan Neiman, manager of the Williamsville, N.Y.-based Neiman Large Cap Value Fund ( NEIMX), his investment in Archer Daniels Midland is based on the principles that the company has substantial value and it pays a nice dividend.

"In my mind, it's a same situation with a lot of names in our portfolio," Neiman explains. Along with his father, Harvey, Neiman has managed the fund for seven years, hunting for companies with value and dividends. They also purchase conservative covered call writing on stocks to capture the option premium.

The $20 million fund owns about 13,000 shares of ADM, making it one of the fund's top holdings. Neiman built a position over the years in what he calls "a company that isn't a high flyer but they continue to do what they do and they do it well."

From a macro perspective, Neiman says Archer Daniels Midland is an attractive play as it's closely tied to the global economy recovery.

"As the prices of commodities continue to go up, the dollar weakens," Neiman says. "As that occurs, they outperform and profit goes up. Of course, I can't say that every agricultural or farming company is going to do awesome this year. But I can say that ADM is poised to do well. They have a stronghold in the industry."

Jerry Jordan says the Jordan Opportunity fund also owns Archer Daniels Midland. Although he has trimmed his position, he maintains it as a top 20 holding in the fund because "it's the poor man's agriculture exchange traded fund."

"ADM has a lot of moving pieces," Jordan says. "They are an incredibly well-run company that have so many businesses with so much volatility. Predicting is hard quarter to quarter. But much like a Chevron ( CVX), it's a fine idea relative to the market. It's not going to be smooth, but if you believe in the overall cycle, it's a good way to play it."

"I just wish it were less volatile than it has been," Jordan adds.

-- Written by Robert Holmes in Boston.

>To contact the writer of this article, click here: Robert Holmes.

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Disclosure: TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.

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