Summary
When an investor is looking for companies in which to invest, there are certain attributes for which to look that indicate a higher chance of success. First, there must be high barriers to entry in order to limit competition, essentially creating a wall around the industry that is difficult to penetrate.
In essence, this situation allows the existing competitors to have a sort of monopoly on the industry with little threat of it being infiltrated by outsiders. The next characteristic that one looks for in a company is brand name recognition. Brand names offer economies of scale, widespread availability, and favorable display space, not to mention loyalty and the indication of a history of success. Another attribute that suggests success is a high return of invested capital, also known as return on capital (calculated by dividing net income minus dividends by total capital).
Invested capital tells people how well a company invests to produce revenue. If the company has a higher return on capital than its competitors, then it is doing a better job of managing its money. The last integral characteristic is reasonable growth opportunities as it generally holds true that if it has been growing steadily, there is a strong probability that it will continue to do so in the future. This includes looking into the industry in which the company operates within, as companies that operate in a growing industry will likely offer greater growth potential.
Company description
Caterpillar is a manufacturer of construction and mining equipment, diesel and natural gas engines, industrial gas turbines and diesel electric locomotives. It was incorporated on March 12, 1986 and is headquartered in Deerfield, Illinois. The segments in which it operates include Construction Industries, Resource Industries, Energy & Transportation, Financial Product, and All Other operating segments.Caterpillar’s machines are distributed through a third party serving countries both nationally and internationally, reaching more than 190 countries. Their major products consist of construction, engineering, and building products, electrical equipment, and industrial machinery.
Country Analysis
Macro-economic analysis:
Caterpillar’s business is heavily influenced by the surrounding economic conditions. The demand for the products in the industry tends to be cyclical; it is especially reduced during times of economic crisis highlighted by very low government spending among other factors. The economic conditions are different for every region and therefore the demand is not constant throughout the world. Positive demand is jump-started by high government spending, economic growth, and strong investment.
Political Analysis:
Caterpillar is severely positively and negatively influenced by the political climate worldwide, especially in the United States and in China. With President Trump’s trillion dollar infrastructure plan it would increase Caterpillars revenue tremendously but because of the new tax laws that President Trump proposed it would limit the already depleted capital the government has at their disposal to invest in infrastructure and Caterpillar might suffer the consequences.
The ongoing trade war between the United States and China can possibly negatively impact Caterpillars growth. Another potential growth for Caterpillar will be through the new Omnibus spending bill which includes spending on the military to continue to strengthen it. Caterpillar does supply certain heavy machinery and training on those machinery to the government and military which will increase its potential growth in the near future.
An additional risk arises in terms of currency exchange rates. Each government chooses its own economic and business policy according to their political agenda and that leaves monetary and fiscal policies susceptible to sudden changes. A change of this sort can impact the company’s performance in both the short and long terms.
Market Analysis:
SWAT Analysis Strengths
It has a strong brand name and R&D, strong global distribution network and its large-scale assets. Caterpillar’s name is well-known around the world and spends over $2 billion a year in R;D to stay competitive and stay ahead of the competition. Their large-scale assets and efficient production allows them to produce product in large quantities.
Weaknesses: Caterpillar’s weaknesses are is that is does not innovate at a high rate, does not have so many connections in emerging markets, Debt & Solvency, and the 2016 performance and low Demand. Low rate of innovation makes Caterpillar susceptible to competitors aggressively investing in technological innovations in the machinery sector. Since they don’t have so many connections in emerging markets it prevents them from maximizing revenues. Caterpillar’s Debt to Equity ratio was at 2.78 in 2016, while its competitor Atlas Copco, was at 0.478 . Caterpillar’s debts and solvency positions can potentially harm its ability to borrow more money and pay reasonable interest rates.
In 2016, their ROE was -0.5% and ROIC was 2.5%, which are well below their WACC of 6.87%. This hurts shareholder value and shows that there are weaknesses that must be fixed through the current restructuring plan.
Opportunities: Caterpillar’s has multiple ways to grow and increase revenue, while still maintaining its competitive edge over other competitors in the industry. The company has a major opportunity for growth if it decides to expand in some of the emerging markets. After expansion, Caterpillar can grow by creating new products and services that adhere to the the global market.
Threats: One of the biggest threats towards Caterpillar is the threat of another company simply copying their strategies and services. Another major threat towards Caterpillar is if a competitor obtains a technological advancement, such as if a competitor is able to integrate robotics into their products to make them more productive and efficient.
Industry Analysis Porter’s 5 Forces
Threat of New Entrants: Threats of new entrants creating machinery in construction and farm puts pressure on Caterpillar by lowering their prices, creating more benefits for the customer, reducing costs. However, there is a high barrier to entry because one needs a lot of capital investments, high technical expertise required, and the name brands like Caterpillar, Komatsu, John Deere, and Volvo and have a strong foothold on the industry. The threat of new entrants is low, getting entry and winning orders from global companies is unlikely from a new entrants but it is possible.
Caterpillar has to tackle all of these issues strategically and build an effective barrier to entry to protect its competitive edge in the construction and farm machinery industry(Krause Fund Research).
Bargaining Power of Suppliers: Basically all the companies in the farm and construction machinery industry buy their raw materials from many different suppliers because it has different manufacturing locations around the world. These suppliers can decrease the margins Caterpillar Inc. and other companies can earn in the market.
The main suppliers in the farm and construction industry use their negotiating power to extract higher prices which then lowers the overall profitability of the farm ; construction machinery sector. Caterpillar Inc. can combat the bargaining power of the suppliers in several ways: testing product designs using different materials just in case the price goes up of one material they can then switch to another, building efficient supply chain with many different suppliers, and creating dedicated suppliers whose business strategy depends upon Caterpillar. The bargaining power of suppliers is low(Fern Fort University).
Bargaining Power of Buyers: The bargaining power of buyers is low because of the limited options. The bargaining power of the buyers: buyers want to buy the best product by paying the least amount of money. Caterpillar Inc. can combat the bargaining power of buyers by building a large base of customers which will help reduce the bargaining power of the buyers and will provide the ability to streamline its sales and production process, constantly coming out with new products since customers always want a discount on current products so if they constantly come out with new products then it will limit the bargaining power of buyers and it will also limit the amount of customers leaving to competitors. The buyers have little buying power because they usually have a couple of large manufacturers who strategically help them with their business(Krause Fund Research).
Threat from Substitute Products: The threat level for substitute products is relatively low since the entry price for new competition is very expensive. For existing competition, upgrading the quality of the product is also extremely costly. Caterpillar has this great competitive edge because of its supply chain acquisitions from the past couple of years. One example of these supply chain acquisitions was when Caterpillar’s acquired a company called Bucyrus International, in 2010.
With the acquisition of Bucyrus, Caterpillar was now able to expand its services to a larger portion of the mining industry than before. Another reason why Caterpillar has a low threat of substitutes is because out of all the competition, Caterpillar has the lowest channel costs as long well as an spectacular asset utilization.
Caterpillar has 3 main sources of revenue- construction & excavation, resources & mining, and engines & power systems. Another reason why Caterpillar has a low threat of substitutes is because Caterpillar has very strong consumer relationship management which helps them retain their customers for future business.
The customers continue to remain loyal as Caterpillar “remains locked-in with their customers for future business arrangements through its ancillary subdivisions.” Caterpillar remains free of competition since it’s “the most convenient option for “all-in-one” service provision, the consumer benefits from a “one-stop-shop” when looking for alternatives.” Caterpillar is also much more efficient than their competitors since it’s costs to provide service are significantly lower.
The expensive nature of the industry helps create a barrier for Caterpillar to prevent new competitors in the industry. Caterpillar has kept costs low through the use of multi-purpose equipment, which eliminates the need for an alternative product. Through this strategy Caterpillar has created tons of demand for its equipment because it helps limit the customer’s overhead costs. The equipment serves as a cost effective replacement for human labor. Caterpillar should have no problem maintaining control of the industry and there should continue as low threat of substitutes as long as they “continue to utilize their optimization strategies.”
Rivalry among the existing players: Caterpillar Inc. competes in a very competitive industry. There are significant competitors from Sweden, Japan, Germany and the Netherlands. These competitors are very involved internationally and have engineering expertise comparable to Caterpillar. They compete on customers, performance, price and quality.Caterpillar can combat the competitiveness by creating a sustainable edge in their product over the other companies, teaming up with competitors to increase their market size, and by growing the business so that it can compete better on pricing(Andrew Thompson).
Life cycle of the industry and the company’s position with respect to the industry: There are five steps in the life cycle of the products in the industry. The first stage is supply chain in which the company finds a supplier or multiple ones that they can trust in order to form a partnership. The second step is manufacturing where the products are being produced at maximum efficiency while simultaneously being cautious to conserve energy and reduce water and waste.
The next stage of the life cycle is the distribution phase in which the products are dealt out to the appropriate customers. The fourth step is usage where the products are actually put into action and utilized to their highest potential. The last stage is the end-of-life management in which the products are either recycled or properly disposed. Strengths and weaknesses or specific risks of the industry: There is great potential for the industry as the population growth is driving up all types of transportation from highway to railroad to marine transport.
There are also a large amount of related areas into which companies like Caterpillar can expand including electrical engines, robotics, and semiconductors. Additionally, data analytics have taken over the world recently and can have a significant impact impact on the industry in terms of finding ways to reduce fuel consumption. While the outlook for the industry does have some opportunity, there is also a great amount of risk surrounding the industry. In the past several years, the combination of excess capacity, weaker economic conditions, and currency fluctuations have resulted in high competitive pressure. Companies throughout the industry all faced decreasing profits and revenue throughout the last several years.
Yet another risk of the industry is the unpredictable amount of infrastructure investment from the government. While the current governments in the United States and China have advocated for higher infrastructure investment, the same cannot be said for the rest of the world as a whole. This volatile situation creates high risk amongst all involved in the industry.
Company specific analysis Disclosure: analysis of the disclosure provided by the company. For the interpretation of the company-specific information you should consider the environmental (institutional) context (i.e, cultural, financial mores, legal, tax) Caterpillar is being far too vague in their disclosure regarding environmental safety as they posit, “We have made, and will continue to make, significant research and development and capital expenditures to comply with these emissions standards.
