The only "bear" warning: investors are overvaluing Caterpillar

Morgan Stanley analyst Angel Castillo believes that the market is too optimistic about Caterpillar's prospects, despite a surge in demand for its data center equipment. The Power Generation segment did show sharp growth thanks to AI infrastructure, but the analyst says that's not enough to offset weakness in the core construction business. He recommends selling the stock, believing its value will fall by about 30% over a 12-month horizon. Meanwhile, the securities have already started to correct from their October high amid a market sell-off.

Morgan Stanley analyst Angel Castillo said he believes it is unlikely that the business of heavy construction equipment manufacturer Caterpillar will recover quickly, despite the recent excitement around its Power Generation segment. According to him, investors are too optimistic about the company's prospects, Bloomberg writes.

Caterpillar has long remained an "unobvious" beneficiary of the AI boom: it derives most of its revenues from the sale of construction, mining and energy equipment. However, the situation changed when the Power Generation segment, which produces backup generators, faced a sharp increase in orders from companies building data centers for AI servers.

The Power Generation segment accounted for 15% of Caterpillar's quarterly revenue, which reached $17.6 billion in the third quarter. The company said in a statement that generators and turbines, which are needed to keep AI infrastructure running smoothly, were one of the key drivers of revenue growth. Power equipment sales climbed 31% - much faster than the traditional construction segment.

Against this background, investors saw in Caterpillar shares a new source of profit. After the publication of reports for the third quarter on October 29, shares of Caterpillar jumped by 12%, renewing the maximum since March 2009.

According to Castillo, investors are confident that Power Generation's direction will be so strong that it will "override" any cyclical risks in the company's other segments. "I think there will indeed be growth," the analyst notes. - But not enough to offset the impact of all the other factors."

The analyst warns that any slowdown in investments in data centers will inevitably hit Caterpillar as well. Therefore, even in the most promising direction of the company there will be risks, Bloomberg notes.

Caterpillar shares have risen 51% since the beginning of the year and are now trading at a multiple of 25 to expected earnings over the next 12 months. However, since the end of October, Caterpillar shares are already down more than 6%. On Tuesday, November 18, the drop was as high as 2.5% - amid concerns about overheated valuations of AI-related companies. Quotes ended the session with a decline of 0.9%.

As Bloomberg writes, Castillo recommends selling the stock and sets his target price at $380 - the lowest forecast on Wall Street and about 30% below the current value. By comparison, 14 analysts advise buying the stock and another 12 advise holding.

This article was AI-translated and verified by a human editor