That’s right, oil and gas. Fossil fuels don’t get a lot of love these days. But the purchase demonstrates potential benefits of industry consolidation and has the potential to boost several U.S. stocks by getting investors to think about the impact of mergers and acquisitions on portfolio returns.
Weir (ticker: WEIR.London) makes smaller equipment than Caterpillar (CAT) and the huge mining machines investors associate with the iconic American manufacturer. Caterpillar is acquiring a portion of the overall Weir business that makes pumps, valves and flow-control products for energy, power and mining markets.
“Combining Weir Oil & Gas’s established pressure pumping and pressure control portfolio with Cat’s engines and transmissions enables us to create additional value for customers,” Joe Creed, vice president of Caterpillar’s Oil & Gas and Marine Division, said in the company’s news release. “This acquisition will expand our offerings to one of the broadest product lines in the well service industry.”
Caterpillar is paying $405 million in cash. It looks to be paying about 0.67 times sales and about 10 times recent Weir divisional operating profit. That is fairly attractive, compared with the broader industrial universe, which trades for roughly 2 times recent sales and 15 times operating profit.
Oil-and-gas markets, however, have been depressed. Energy components in the S&P 500 are down about 50% year to date and trading for about 0.67 times sales. Energy companies aren’t generating much profit and oil prices are a big reason—down about 36% year to date and down more than 50% from recent highs.
“The fact that Weir has managed to find a buyer of the asset at a very tough point of the [industry] should be encouraging as regards Ingersoll-Rand’s ] ability to continue to enact portfolio transformation over the medium term,” Barclays analyst Julian Mitchell wrote in a Monday research report. “Investors have long wanted [Ingersoll] to reduce its upstream [energy].” The likelihood of divestment is higher given the Weir deal. Ingersoll is a Weir competitor.
(Upstream refers to oil drilling and exploration. Downstream refers to operations such as refining and chemical production.)
All five stocks mentioned are down year to date and the average drop is about 14%, worse than comparable returns of the Dow Jones Industrial Average and the S&P 500. They trade for about 20 times estimated 2021 earnings, but earnings are below prior years.
Caterpillar stock is up 3.7% year to date. The shares were up 2.6% Monday morning after the deal was announced and on the strength of the overall market. The S&P 500 was up 1.4%.
Energy and transportation markets, which include marine and rail markets, account for about one third of total Caterpillar sales.
The deal is small for Caterpillar, which has a market value of more than $80 billion. Investors will get a chance to ask management about synergies when the company releases its earnings on Oct. 27.
They can also ask about potential benefits of industry consolidation in the oil-and-gas sector. That can be one way to stabilize and improve returns when commodity prices, and demand, are falling.
Write to Al Root at firstname.lastname@example.org