CAT Trade Update and A Quick Look at Friday’s Earnings

by Dan April 28, 2011 6:36 am • Commentary

CAT reports Friday morning before the open.

-Options Market currently implying about a 3.5% move vs the 8 qtr average of ~3.3%

-On April 1st, I took a look at the name as they had just hosted an annual analyst meeting /gave some Q1 guidance, as the stock was also making all time highs (post below).

-At the time I suggested 2 strategies, one defensive against a long and one outright bearish.  Both would have worked out just fine for a couple weeks as the stock sold off ~10%, but has since made back all that ground back within a buck of the previous all time highs.

-As I think about what to do now in this name, one can’t ignore the market environment that we are in, and for the most part for the time being all signs point to up.  Industrial companies such as CAT have many tailwinds in this economic environment and shorting it could be fairly painful as it it appears poised to break out to a new all time high.

-I have been too bearish as I have been expecting a bit of a pullback in the market at the signaling of the end of QE2…I know, I know it was telegraphed but a guy can still hope can’t he??

-If I was long CAT, I would probably still favor defensive collars to protect around what is also a telegraphed event, but I am bit skeptical about continuing my overly bearish posture (some may want to use this as a contrarian indicator!), as the market is proving me wrong on almost every tick.  That doesn’t mean there still isn’t opportunities to make money on the short side though…..may just need to let the rally blow off a bit and then get back in there.

-I got spoiled, I had a couple nice winners early in the earnings cycle and was looking to spread around some of the wealth on lower probability bearish bets that are now hurting a bit (CTXS, AMZN and INTC).

-As for CAT the stock is probably going up, they will have good earnings and guidance and it is probably off to the races…..but I still can’t get long stock like this.


I am going to do something I almost never do, but I am going to refer to the irrelevant Dow Jones Industrial Average…..of the 30 stocks in the index almost a third of them are up over 10% ytd, with CAT up almost 19%, the largest gainer of the group.


-What I find most interesting of CAT’s performance YTD is that most of the year it had been tracking the performance of the SPX, but since the index’s bottom on March 16th the stock is up 10% and handily outperforming the broader market (below). The company is widely viewed as a beneficiary of the incredible amount of reconstruction required in post disaster Japan. This chart shows as the index dropped to the lows on the year, CAT actually firmed up and did not follow suit.

CAT (white) vs SPX (orange) ytd Bloomberg chart

That very relative strength is the foundation for the breakout of long term resistance and ultimately new all time highs. In my view given the almost 65% surge in the stock since Sept 1, 2010, CAT will have to consolidate a bit before it will be able to make move much higher. This is obviously a very healthy chart as you see below. 3 periods within the 7 month duration where the chart consolidated for a period of weeks which staged the breakout to new highs. What is also of interest to me that in the third such consolidation over the last 6 weeks it became very apparent that the volatility bands in the stock had clearly widened relative to the last 2 consolidations.

CAT 7 month Chart Bloomberg chart


Clearly a lot of good news is in the stock after the more than 300% rally since the lows in the market made in spring 2009.

-the company was and remains uniquely positioned to benefit from reflation of the global growth scenario where sales in places like China, Brazil and India are fueling much of the company’s growth. Additionally as stated above, the company is a beneficiary of all the construction work needed to be done in Japan.

-CAT held and analyst meeting on Mar 23rd where they reiterated their guidance for Q1, 2011 and gave a range for 2012, and also confirmed a target compound annual growth rate in earnings per share of 15 to 20 percent through 2015.

-The street expects earnings to grow 45% this year and 33% next, while sales growth is expected at 20% and 17% respectively.


– I obviously can’t argue with anything that management had to say at their analyst meeting last week and the confidence they have in their visibility out to 2012, but one thing I can say is that this is a very cyclical business. in the last 6 years CAT has seen their earnings growth rise and fall very substantially and it is now in the rising phase again (but expected to decelerate), is that in the stock at this point? the following are actual earnings growth rates for the last 6 years: 2005 /+41%, 2006/+30%, 2007/+2%, 2008/+5%, 2009/-61% and 2010/+97%

-Company hasn’t set a reporting date yet, but likely to be in late April. And at this point I am not sure that it matters as they have already essentially pre-announced.

-But stocks that move up like this in one direction are crowded trades and if there are any reasons to sell, as simple as market selling off, nothing company specific, than they tend to go down quickly as lots head for the door at the same time.

SENTIMENT: there are 13 buys, 9 holds and no sells. Analysts have an average 12 month price target of ~117 and short interest sits at a fairly low 2% of the float.



TRADE 1: BUY MAY 120/ 105 Collar for 1.20 or ~1% of the stock price (ref 111.35)

-Sell the May 120 call at 1.25 and use the proceeds to

-Buy the May 105 Put for 2.45

Break-Even on May Expiration:

Upside: gains btwn 111.35 and 120, long stock called away at 120 (up almost 8%, which would place the stock up ~27% ytd) but you have to deduct the 1.20 premium from the gains.’

Downside: Protection below 103.8o (105 strike put less the 1.20 in premium you paid for the structure). Below 103.80 (down ~6.5%) you have unlimited protection.


-This has been a one way trade, UP. If you are fortunate enough to own stocks like this I suggest from time to time around events or when you deem the market to be at an inflection to use some of the gains to put on defensive structures in a tactical manner. Collars that offer protection with similar break-even levels to their call-away levels should have particular interest as you get a sense that you are not paying too much for that protection.

TRADE 2: Outright Bearish Bet that the stock needs to consolidate before it can move higher. If you are of a similar mindset to me that Q2 guidance and possibly the fed signaling the end of quantitative easing at their Apr 27 FOMC meeting could cause a sell off in the market, then names like CAT will certainly be affected regardless or in-spite of all the good news in the stock..

TRADE: BUY May 105 / 100 Put Spread for 1.10

-Buy May 105 Put for 2.45 and

-Sell May 100 Put at 1.35

Break-Even on May Expiration:

Upside: btwn 103.90 and 105 lose up to 1.10 (~1% of the underlying), above 1.05 you lose all 1.05.

Downside: Btwn 103.90 and 100 you can make up to 3.90 (or ~3.5%), below 105 you make the full 3.90.