The target price was cut by 26% overnight! Damo: The AI myth of Caterpillar (CAT.US) is being debunked little by little by the cycle

The Zhitong Finance App learned that in the newly released research report, Morgan Stanley drastically lowered the target price of Caterpillar (CAT.US) from 915 US dollars to 675 US dollars, clearly judging that the stock has moved from AI-driven valuation expansion and officially moved into the “cyclical valuation correction” stage. Although Damo maintains a “hold and see” rating and an “attractive” industry view, it bluntly says that the market has already set the stock price to a “perfect” level and that there is little room left for fault tolerance. The new target price implied an upward space of only about 4%.

Caterpillar's third-quarter results slightly exceeded expectations, and full-year guidance was maintained, but the stock price still plummeted 9.25% on the same day. AI sentiment has driven its stock price to new highs earlier this year. Damo believes there are three key points:

First, orders declined month-on-month. The order volume for the third quarter was about US$25.6 billion, down about 11% from the previous quarter, which was significantly lower than the buyers' previous expectations of more than US$29 billion, increasing concerns about “peaking profits”.

Second, poor performance and guidance. Driven by manufacturing costs and inflationary pressure, the third quarter results and fourth quarter guidance fell slightly short of expectations. Morgan Stanley lowered its EPS forecast for the fourth quarter from $7.59 to $6.39, $28.38 to $27.24 for the full year of 2026, and $33.22 to $31.49 in 2027.

Third, the construction industry removes inventory. The company lowered its construction industry (CI) forecast. The volume of dealers' inventory removal in the fourth quarter is expected to be close to 1.6 billion US dollars, higher than the previous forecast of 1 billion US dollars.

Notably, Morgan Stanley previously clearly warned of two major downside risks: doubts about the sustainability of the data center power generation equipment cycle, and more drastic inventory removal in the construction industry. Now these two major risks are being realized one by one, and the stock price is recovering as a result.

By sector, the resources industry (RI) benefited from favorable price realization, and revenue and profit margins were raised; power and energy (P&E) revenue declined slightly; and the construction industry (CI) operating margin was expected to drop by about 318 basis points in the fourth quarter due to inventory pressure.

At the valuation level, the new target price is based on 21.5 times the 2027 EPS. Morgan Stanley calls it the “top to bottom of the cycle” valuation, compared with the historical 11-22 times forward-looking price-earnings ratio range. The previous target price of $915 was based on “what do you need to believe” for multi-stage DCF growth. Assuming a compound sales growth rate of 8% from 2025 to 2030, this is “not an easy task.” Morgan Stanley expects the stock price to fluctuate between $550 and $800 in the medium term.

However, the bank has not downgraded to a “reduction in holdings” for three reasons: the stock price has retracted about 40% from its all-time high of $1,073; orders are steady even though they have peaked, and there have been no major cancellations; and the company has abundant free cash flow, which can support the stock price through repurchases.