After a 160% AI-Fueled Rally, Can Caterpillar Stock Keep Climbing?

Key Takeaways

• Caterpillar’s power and energy business is emerging as a major growth catalyst as AI-related data center spending accelerates.
• Management recently raised its long-term outlook for the stock, citing stronger demand for large engines and power-generation equipment.
• Shares may reflect significant optimism, despite improving fundamentals

While the general public might know Caterpillar CAT by its trademark yellow heavy machinery, the firm’s less-visible power and energy business is helping its stock ride the artificial intelligence boom higher. While the company is firing on all cylinders thanks to data center demand, its valuation after a big rally might be flashing a warning sign.

Shares of Caterpillar are trading near their all-time high, climbing roughly 60% this year through June 3. That’s the stock’s best start to a year in its history and its best annual gain since 2017, when it rose 75%. The stock is up more than 160% year over year.

The rally reflects growing investor enthusiasm for the company’s power and energy segment, which has emerged as one of its fastest-growing businesses amid surging investment in AI infrastructure. “Unquestionably, [data center demand is] rather transformational to the investment thesis,” says Morningstar analyst George Maglares.

A Retooled View of Caterpillar for the AI Era

Caterpillar traces its history back to the late 1800s, a century before the personal computer was invented. Five years ago, the company’s biggest revenue segment was its construction industries division. But more recently, the power and energy business has become its biggest earner.

The shift was evident in Caterpillar’s first-quarter results. Power and energy sales increased 22%, and management raised its long-term outlook only months after Investor Day, announcing plans to triple large-engine capacity and power-generation sales from 2024 levels. Previously, the company expected those figures to double. “Clearly, the order books are coming in better than had been anticipated,” says Maglares.

While investors have traditionally viewed Caterpillar as a cyclical play on construction, mining, and industrial activity, Maglares says it’s becoming increasingly important in the AI ecosystem through its ability to provide power-generation equipment for data centers.

Data Centers Could Deliver Recurring Revenue for Caterpillar

“The discussion is evolving to providing primary sources of power to the data center,” Maglares says. “They also offer turbine engines that could be authentic sources of primary power for data centers, and that is perhaps an underappreciated avenue of growth.” He notes that Caterpillar is expanding its addressable market by providing primary power solutions in addition to backup generators, broadening its exposure to one of the fastest-growing areas of infrastructure spending.

The opportunity could become even more attractive if Caterpillar generates recurring revenue from servicing those assets. “When you have strong brand-new order growth, then start forecasting multiple years beyond that original sale, that creates a very lucrative, highly visible stream of incremental earnings,” Maglares explains.

He thinks the growing contribution from the power and energy division could also make the company less cyclical over time: “It’s very fair to argue that the contribution to Caterpillar’s revenue and earnings from these activities is going to reduce the business’s economic volatility through the cycle.”

That view aligns with Morningstar’s broader thesis that services growth, connected assets, predictive maintenance, and power-generation exposure are helping improve the company’s earnings durability. Caterpillar is targeting $30 billion in annual services revenue by 2030, after reaching $24 billion last year. Caterpillar is ”a best-in-class operator with significant leverage to AI data center buildout,” Maglares says.

How Well Can Caterpillar Capitalize on the Data Center Boom?

Despite the improving outlook, Maglares remains cautious on valuation. He recently raised his fair value estimate for Caterpillar stock to $680 per share from $620, in response to stronger expectations for the power and energy business and improving conditions across construction and resource industries.

Still, with shares trading above $900, Maglares thinks investors are already assuming a highly favorable outcome. “To justify a valuation at these levels, you have to be looking at effectively double-digit sustainable earnings growth on a year-six-through-20-type horizon,” he says.

While he acknowledges that such growth could ultimately materialize, he believes the stock may be running ahead of fundamentals: “I think it’s perhaps a bit ahead of its skis.” For Maglares, the investment case will ultimately come down to Caterpillar’s ability to capitalize on one of the most significant infrastructure buildouts in recent memory.

Bulls Say

• Management may be understating the group’s margin potential of 18%-22%, as further services growth is likely to be margin-accretive. There is a spread between the core construction segment and the others that could narrow.
• Expansion of digital solutions and greater penetration of existing customers via upselling should drive greater pricing power for Caterpillar.
• Caterpillar’s autonomous truck solutions could help it win new customers, especially in the global mining industry.

Bears Say

• Due to Caterpillar’s cyclicality, management profit margin targets may not be maintainable through the business cycle. Worse decremental margins would imply the value proposition to customers isn’t as robust.
• Global competitors could make inroads against Caterpillar’s product quality, dealer network, and financing capabilities to take market share.
• Management’s growth objectives are unrealistic regarding mining/commodity demand and the global energy transition.