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Stretched Valuations in Heavy Equipment

Overly optimistic assumptions about the impact of a Trump infrastructure plan have left many heavy equipment manufactures looking pricey.

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Kwame Webb: Our heavy equipment coverage includes marquee construction, agriculture, truck, and engine manufacturers such as Deere, Caterpillar, Cummins, and Paccar.

In 2016, this group had a median total return of 45% and a 14% return since the November election results were announced. Although many of these companies are exposed to the increased infrastructure spending plans of our president-elect, we would note that direct exposure to North American construction spending is 20% or less of sales for many of these companies and that the magnitude of spending contemplated by the government only translates into an incremental 1-3% of sales over a 10 year period.

Lastly we would note that earnings for many of these companies have declined for the past several years, due to relatively young customer fleets and spare capacity that needs to be absorbed before customers will buy new equipment.

In early 2016, we widely touted many of the names as undervalued despite end markets with excess equipment. Today, the peer group of stocks is fairly to overvalued on lofty government spending and tax assumptions, and we would particularly note valuations are most stretched for Caterpillar and Cummins, where we expect sales to continue to decline into 2017.

Kwame Webb does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.