Rising Tariffs And Decarbonization Will Crimp Long-Term Margins

Key Takeaways

• Trade protectionism and rising compliance costs threaten Caterpillar's margins, while evolving industry dynamics accelerate price competition and commoditization.
  
• Shrinking demand for traditional equipment, due to decarbonization and sluggish infrastructure spending, limits growth in Caterpillar's core markets.
  
• Strong demand across all segments, favorable industry trends, and expanding recurring revenues are driving sustained growth, margin improvement, and increased financial resilience for Caterpillar.

Catalysts

Manufactures and sells construction and mining equipment, off-highway diesel and natural gas engines, industrial gas turbines, and diesel-electric locomotives in the United States and internationally.

• Ongoing and accelerating trade protectionism, particularly the $1.3 billion to $1.5 billion annualized tariff headwind, could become a semi-structural drag given Caterpillar's complex and globally integrated supply chain, with mitigation options slow, costly, and unlikely to fully restore prior operating margins; this threatens long-term margin and operating profit recovery even if volumes remain robust.
  
• Global decarbonization efforts and energy transition initiatives are expected to intensify, leading to structurally declining demand for traditional heavy equipment in coal, oil, and other carbon-intensive resource sectors. With coal-related sales already showing declines, this will further erode Caterpillar's medium
• and long-term addressable market, limiting top-line growth.
  
• Automation and digital disruption within the construction and mining industries are progressing, and while Caterpillar is investing in new technologies, these shifts open the door for new technology-first entrants. As equipment becomes less labor
• and capital-intensive, this could accelerate commoditization and put sustained long-term pressure on Caterpillar's pricing power and ability to command premium margins.
  
• Developed markets, especially in Europe and North America, are facing stagnant to declining population growth and persistent public fiscal pressures, raising the risk of shrinking long-term public infrastructure spending. Combined with aging infrastructure, this could result in choppy or declining demand for Caterpillar's core products, impacting revenues and increasing earnings volatility.
  
• Intensifying competition from well-capitalized international manufacturers-especially lower-cost Chinese OEMs-alongside mounting global emissions and sustainability regulations will drive up compliance costs and intensify price competition, putting persistent downward pressure on Caterpillar's net margins and long-term profitability.

Caterpillar Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on Caterpillar compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Caterpillar's revenue will grow by 2.1% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from 14.9% today to 16.8% in 3 years time.
• The bearish analysts expect earnings to reach $11.2 billion (and earnings per share of $24.84) by about August 2028, up from $9.4 billion today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 16.4x on those 2028 earnings, down from 20.7x today. This future PE is lower than the current PE for the GB Machinery industry at 23.3x.
• Analysts expect the number of shares outstanding to decline by 3.39% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.44%, as per the Simply Wall St company report.

Caterpillar Future Earnings Per Share Growth

Risks

• Record-level backlog of $37.5 billion and strong order rates across all segments indicate robust customer demand and visibility into future sales, improving top-line growth and supporting revenue resilience.
  
• Significant long-term secular tailwinds from global infrastructure investment, energy transition, and urbanization are driving sustained demand for Caterpillar's equipment, which can lead to continued growth in sales and earnings.
  
• Planned capacity expansions and operational efficiency investments, especially in Energy & Transportation, are expected to drive higher throughput and productivity, supporting profit margin expansion and higher operating leverage over time.
  
• Healthy financial products segment performance, with record retail new business volumes and historically low past dues and credit losses, indicates strong customer financial health and adds a growing stream of high-margin recurring revenues.
  
• Ongoing success of merchandising and digital service programs is generating incremental volume and boosting recurring service revenue, which could enable Caterpillar to offset margin headwinds and improve both net margins and overall earnings quality.

Valuation

• The assumed bearish price target for Caterpillar is $342.0, which represents the lowest price target estimate amongst analysts. This valuation is based on what can be assumed as the expectations of Caterpillar's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $520.0, and the most bearish reporting a price target of just $342.0.
  
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be $67.1 billion, earnings will come to $11.2 billion, and it would be trading on a PE ratio of 16.4x, assuming you use a discount rate of 8.4%.
  
• Given the current share price of $416.52, the bearish analyst price target of $342.0 is 21.8% lower. Despite analysts expecting the underlying buisness to improve, they seem to believe the market's expectations are too high.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.