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Dec 21, 2016

S3 BLACKLIGHT: Caterpillar’s Rally Not Attracting Many Shorts

Caterpillar Inc’s (CAT US) stock price has been performing well after the presidential election following President-Elect Trump’s pledge to increase domestic infrastructure investment. CAT’s stock price is up 12.11% since November 8th and up 38.15% year to date. CAT stock hit a year to date high of $97.33/share on December 7th.

Unfortunately, Caterpillar’s stock performance does not mimic Caterpillar’s financial performance. Recently reported November retail sales were down 17% year on year, the 48th straight month that Caterpillar reported declining sales figures. Even after lowering internal costs by $2 billion over the last two years, weak sales in the mining and construction sectors have produced a 20% year on year drop in sales and a 35% year on year drop in EBITDA. Moody’s recently cut Caterpillar’s rating from A2 to A3 and does not see an appreciable increase in new machine sales until 2018. If worldwide sales rebound, Caterpillar’s slimmed down operations will be highly profitable and competitive, but in the meantime they are treading water until customer Capex spending rebounds.

Besides a healthy stock price return in 2016, another reason why investors are holding on to their CAT positions is their 3.28% dividend which outgoing CEO Douglas Oberhelman has vowed to protect. But if free cash flow continues to decline, Caterpillar will have problems sustaining such a high dividend with net revenues declining year after year. Caterpillar has already suspended a portion of their stock buyback program in order to have enough cash on hand to continue paying their $3.08/share full year dividend.
Caterpillar’s short interest is up $412 million on the year, or 13%, bringing its overall short amount to $3.7 billion. But most of that run-up happened from June to September as short interest has been hovering around the $3.7 billion mark throughout the 4th quarter. Short interest is actually down $48 million, or 1%, in the 4th quarter. Caterpillar’s historical short interest high was $3.8 billion in July of 2014 which was the last time Caterpillar’s stock price was over $100/share.

Caterpillar is an example of a security whose stock price has been rallying all year long but short sellers, for the most part, have not jumped into the offsetting trade. With Caterpillar up over 38% this year on weak financials one would expect momentum short sellers jumping in to the trade every time CAT’s stock price reversed course. CAT’s short term reversals in May and October did not attract any increase in short interest. The absence of short term momentum short sellers who would be entering and exiting their trades in tandem with CAT’s share price movements leads us to believe most of the existing shorts are either longer term fundamental or arbitrage related positions.

With short interest remaining stable this quarter, short sellers are comfortable with CAT’s 6% stock price move this quarter. If and when CAT’s stock price moves in excess of expectations we will see its short interest increase quickly and significantly. In the meantime, short sellers are holding on to their dry powder until the rewards outweigh the risk of shorting into CAT’s continuing stock price rally.

For more information on the above analysis, please contact:
Ihor Dusaniwsky, Head of Research, S3 Partners, LLC     Ihor.Dusaniwsky@S3Partners.net

The information herein (some of which has been obtained from third party sources without verification) is believed by S3 Partners, LLC ('S3 Partners') to be reliable and accurate. Neither S3 Partners nor any of its affiliates makes any representation as to the accuracy or completeness of the information herein or accepts liability arising from its use. Prior to making any decisions based on the information herein, you should determine, without reliance upon S3 Partners, the economic risks and merits, as well as the legal, tax, accounting and investment consequences, of such decision.

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