Caterpillar valuation could drop further despite strong machinery, Bank of America warns

Bank of America has maintained its buy rating on Caterpillar despite warning that its valuation could fall further as uncertainty over data centre investment persists. A further decline to 10 to 13 times earnings remains possible if profits have peaked or an industrial recession emerges, although Bank of America does not consider this its base case.

Caterpillar's current valuation also appears relatively inexpensive against other machinery and power equipment companies, the Bank argued. Its analysis puts Caterpillar at a roughly 40 percent discount to Deere, its machinery industry bellwether, representing the widest valuation gap seen in recent years.

Bank of America highlighted a free cash flow yield of 5.6 percent as an attractive feature, although it cautioned that legislative uncertainty remains a risk. The bank's assessment of Caterpillar's machinery operations was more positive, supported by construction market share gains, mining orders and improving dealer pipelines.

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Finning, Caterpillar's largest dealer, reported a record backlog and provided encouraging indicators across construction, rental and mining markets. Rental revenue at Finning increased 27 percent year on year in the third quarter and 15 percent on a last-12-month basis, with growth strengthening across regions.

Mining provided another positive signal, with Finning reporting strong South American order intake during the third quarter, particularly in Chile's copper sector. Bank of America is looking to Caterpillar's forthcoming Compact Day for further indications on dealer inventories, fleet expansion, rental demand and equipment mix.