As we start another week, market attention will no doubt be focused again on Europe—as well it should be. The developments in Italy in the coming months may well determine whether the Eurozone survives in one piece (See “Italy and the Fate of the Euro”)—or whether the world economy enters a deep recession again for the second time since 2008.
Europe’s best days are behind it. The continent whose states once controlled globe-spanning empires and which once was the very definition of progress and modernity is now a society burdened by excessive debts and permanently weakened by aging demographics.
But regardless of what happens in Europe, there are several promising pockets of growth to be found in others parts of the globe. For all of the fears of Chinese growth slowing, the country is still growing at a pace that would cause most finance ministers to salivate. A “slowdown” in China still means GDP growth of over 9 percent. Likewise, on the other side of the globe, Brazil, Peru and much of the rest of South America is enjoying a rise in living standards and economic and political stability not seen in decades. India, Turkey and Indonesia continue to enjoy robust growth as well. The average citizen in any of these countries might well wonder what all of the hand wringing in the United States and Europe is about.
In the Sizemore Investment Letter, we’ve been recommending “back door” ways to get exposure to these high-growth countries by buying American and European companies with high exposure to emerging markets. Our preferred way to do this has been through the consumer products sector and mobile telecom sectors. Companies like Procter & Gamble ($PG), Telefónica ($TEF) and Unilever ($UL) have the strength to withstand a potential financial day of reckoning in the United States or Europe while also offering real growth from the rise of the emerging market middle class consumer. But certainly, there are more ways to skin this cat.
The boom in commodities prices and materials stocks since 2000 has largely been an emerging market story. The rise of the middle classes has meant rapid urbanization and massive construction and energy projects that would have been inconceivable not that long ago.
I’ve avoided the building and materials sectors in recent years because, frankly, the “materials as a play on China” trade seemed a little crowded to me. But after a year of gut-wrenching volatility, investors have largely lost interest in growth investing altogether. And to me, this smells like an opportunity for a good contrarian trade. As a rule, I like long-term investable themes that have managed to avoid the attention of mainstream investors. And with investors now shunning materials, I’m starting to like what I see.
Figure 1: Caterpillar vs. S&P 500
Let’s consider Caterpillar ($CAT), the world’s premier maker of construction and mining equipment and machinery. Caterpillar gets a little over a third of its revenues from emerging markets, and that percentage continues to grow. The 2000s real estate boom in the United States and parts of Europe was a boon to Cat’s business and stock price (see Figure 1). But when the boom went bust, the company’s good times came to an end and the stock price fell by nearly 75 percent.
But then, a funny thing happened. Boosted largely by growth in China, South America, and other emerging markets, Cat’s business mounted a comeback. And for investors brave enough to hold on, so did the stock price. Over the past five years, Cat’s share price is up 60 percent vs. a loss of 10 percent for the S&P 500—and this includes the price implosion of 2008.
The third quarter of 2011 was the most profitable in Caterpillar’s history. Both revenues and earnings hit all-time highs. Not bad when you consider that Europe has most likely been in technical recession for most of the year and the United States not far behind.
Caterpillar knows where its future is. It is planning an aggressive bid for China’s ERA Mining Machinery, a major manufacturer of underground mining equipment in mainland China. Should the deal go through, this will most likely not be the company’s last emerging market acquisition.
A worsening of the European debt crisis—or a hard landing in China—would take a bite out of Cat’s growth. But at current prices, it would appear that we are being amply compensated for that risk. Caterpillar trades for just 10 times expected earnings and for less than one times expected sales. It also yields a modest 1.9 percent in dividends. Though that may not sound like much, it’s only marginally lower than the yield you can get on a 10-year Treasury note. And Cat’s dividend, unlike the interest on the Treasury note, will actually grow with time if history is any guide. The dividend has nearly tripled since just the year 2000.
The stock market remains in a state of heightened volatility, and Caterpillar is roughly twice as volatile as the broader market (as measured by beta). So, investors considering Caterpillar should expect a rough ride. I recommend that investors wanting to take advantage of the company’s growth prospects buy the stock on any significant pullbacks. If the volatility of recent months is any guide, we should have plenty of good buying opportunities in the weeks and months ahead.
If you liked this article by Sizemore Insights, you’d probably enjoy The Sizemore Investment Letter, our premium members-only newsletter. Click here for more information.
