Caterpillar

Caterpillar delivered yet another dominant performance this quarter, with sales up 24% to a company record of $20.5 billion. Adjusted operating profit grew 54% to $4.5 billion, and earnings per share grew 73% to $8.17. The company boosted its sales outlook to mid- to high-teens growth.

Why it matters: The performance was impressive across the board. While power and energy have dominated the narrative around Caterpillar in recent quarters, the more “cyclical” segments posted stronger growth. Construction Industries grew 35% to $8.3 billion and margins expanded 320 basis points to 23.3% with strong volume and pricing. North America grew 50%. Specifically, management highlighted plans to expand its equipment rental business through its dealers to meet booming demand for megaprojects in North America. Resource Industries grew 20% to $4.6 billion and margins ticked up 40 basis points to 14.9%. Rising demand for copper and gold, as well as for aggregates for general construction, was a driver.

Long view: The data center-driven opportunity remains staggering. The segment grew 17% to $8.2 billion, and margins expanded 250 basis points to 24.6%. The power generation segment grew by 29%, and CEO Joe Creed said on the call about demand for artificial intelligence, “no one is slowing down at the moment.” The company elaborated on opportunities in both backup and primary power generation. Even as they add capacity, they are already taking orders into 2029 and 2030. We were particularly impressed that the company repurposed a formerly shuttered marine engine plant to meet demand.

The bottom line: We are increasing our fair value estimate for wide-moat Caterpillar to $720 per share from $680, driven by improved guidance and the time value of money. The shares have pulled back recently as a prominent short-seller has taken a position against the company, and we concede our valuation contemplates tremendous growth.

We derive a fair value estimate for Caterpillar of $720, reflecting the company's increasingly strong outlook for data center solutions from the power and energy business, as well as recovery scenarios in construction and resource industries. Our fair value estimate equates to about 28 times our 2026 earnings per share. The implied multiple is understandable given that construction and resource industries are both meaningfully off-peak earnings and the accelerating growth driven by power & energy.

Caterpillar ended 2025 with record backlog and improving momentum across its portfolio. The company published ambitious goals for 2030 at its 2025 investor day, which it proceeded to increase only a few months later given a continuously improving outlook at power and energy, in particular. We forecast a recovery/acceleration to high-single-digit growth across the more cyclical reporting segments in 2026 (construction and resource industries). We believe the medium-term drivers are broadly supportive of the company maintaining mid- to high-single-digit revenue growth across the three reporting segments in our five-year forecast horizon. We argue that the machinery segments will be able to maintain margins at modestly higher levels, which may prove to be conservative if the company continues to enhance its service attachment rates (construction industries' margins have exceeded 25% with minimal evidence of having reached limits). It will be particularly fascinating to observe the potential for further margin uplift across segments should the company face more bullish conditions across the portfolio. Management is in somewhat uncharted territory in realizing the full margin potential of the business, in our view.

Historically, Caterpillar has experienced downturns approximately every five years or so, though these cycles are quite idiosyncratic and difficult to predict. Generally, downturns are comparatively short-lived (six to 18 months) with swift recovery. Given its growing installed base of machines and improving attach rate of services, we believe management truly is enhancing the resilience of the business and reducing cyclicality. This makes margin comparisons to past peak-trough phases more ambiguous. Caterpillar is likely a much stronger business today than in previous cycles.

Our Stage II forecast period incorporates an estimated investment rate of 16% and earnings before interest growth rate of 5% with perpetual growth of 3%. An 8.6% weighted average cost of capital derives from a market-average cost of equity and the firm’s current capital structure.

We assign Caterpillar a Morningstar Economic Moat Rating of Wide, attributable to significant intellectual property and daunting customer switching costs. Throughout its nearly 100-year history, Caterpillar has consistently provided customers with reliable, high-quality products at the lowest total cost of ownership: a true value proposition reflected through maintainable pricing power across its businesses. Caterpillar maintains approximately 150 locations across 25 countries, 125 of which are dedicated to manufacturing. It is reasonable to infer that there is a meaningful degree of buying power and scale economies from the production process. These factors have led to Caterpillar becoming an iconic brand with industry-leading market share. Its products generally operate in harsh environments where durability and high running time are critical characteristics. While its machines may be considered “expensive” or “premium” products, the costs are likely de minimis in the broader context of its customers’ operations (such as building a power plant or operating a mine) where the cost of failure or down time poses far greater risk. As such, Caterpillar’s longer-term operating results reflect meaningful pricing power. Product quality inherently limits the threats from lower-cost, “cheaper” competition because Caterpillar products ultimately justify their value via superior total cost of ownership. Moreover, the firm segments its customer universe by offering products at various price points/levels of features to reduce threats from lower-cost producers. Finally, the company also holds a variety of patents and other intellectual property, particularly across various engine technologies. While these intangible assets don’t explicitly stave off competition, this absolutely reinforces the concept that Caterpillar builds excellent machines and invests in new product features to preserve its edge.

Perhaps even more important than its product quality, Caterpillar realizes a significant competitive advantage in distribution/service through its network of nearly 160 independent dealers with almost 2,800 global locations. The dealers have aligned interests with Caterpillar. While not necessarily exclusive arrangements, Caterpillar tends to represent the bulk of its dealers’ sales/profits. The network is sufficiently dense as to deliver the broadest sales coverage for the OEM and best depth of service for customers through spare/repairs. The asset intensity and process/know-how of the group’s manufacturing activities combined with the scale of the dealer network are exceedingly difficult to replicate and materially limit competition. The company’s long operating history and leading market position are a testament to the durability of these intangible assets (brands, know-how, distribution, customer relationships).

Caterpillar’s dealer network and captive finance business are not just about moving equipment to customers but also capturing as much of the value chain as possible throughout the product lifecycle. The company bundles vital functions through the dealer network, including financing and aftermarket support/servicing, thus making switching exceedingly difficult for customers. The company’s large, high-quality machines and engines are expensive and perform mission-critical functions for major construction, mining, energy, and transportation projects, often in harsh operating environments. As a result, customers face meaningful operating risk by potentially switching to an alternative product through machine failures or long lead times to service equipment. Customers also make substantial financial investments in costly and relatively long-lived assets (over a 10-year average useful life). While secondary markets exist for Caterpillar products, there is unquestionably meaningful friction in switching them out of a project. In recent years, the company has also prioritized services and is attaching a higher percentage of service contracts at the point of sale. This locks in steadier, high-margin aftermarket sales, which have clearly had a positive impact on the group’s profitability. The quality and scope of the dealer network in terms of availability of parts/service confer a tremendous edge versus competitors because they are best positioned to address customer pain points and keep machines running more frequently at a reasonable cost. The customer clearly perceives value in the context of total cost of ownership.

Management may be understating the group’s margin potential of 18%-22% as further services growth is likely to be margin accretive. There is a spread between the core construction segment and the others that could narrow.

Expansion of digital solutions and greater penetration of existing customers via upselling should drive greater pricing power for Caterpillar.

Caterpillar’s autonomous truck solutions could help it win new customers, especially in the global mining industry.

Due to Caterpillar’s cyclicality, management profit margin targets may not be maintainable through the business cycle. Worse decremental margins would imply the value proposition to customers isn’t as robust.

Global competitors could make inroads against Caterpillar’s product quality, dealer network, and financing capabilities to take market share.

Management’s growth objectives are unrealistic regarding mining/commodity demand and the global energy transition.