We're trimming our estimate after law enforcement agencies executed a search and seizure warrant at three of the company's facilities.
By Keith Schoonmaker, CFA | 03-03-17 | 02:45 AM | Email Article

We have decreased our fair value estimate for  Caterpillar  shares to $64 from $67 following the firm’s press release on March 2 indicating that the IRS, FDIC, and Commerce Department executed a search and seizure warrant at three Caterpillar facilities in Illinois, including the corporate headquarters. Shares declined about 4% on the news. The company advised it believes this action pertains to export filings of Caterpillar SARL in Switzerland.

Keith Schoonmaker, CFA, is director of industrials equity research for Morningstar.

The potential valuation impact is uncertain, but we now assess the taxes and penalties we believe the firm is likely to owe. We suspect the core of the matter is not “new” news, but rather that it relates to the risk already disclosed in 2014-16 10-Ks. The 95-page April 2014 report “Caterpillar’s Offshore Tax Strategy” by the Permanent Subcommittee on Investigations, U.S. Senate, concluded that Caterpillar used parts sales to shift profits from the high-tax-rate U.S. to low-tax-rate Switzerland, thereby cutting U.S. taxes by $2.4 billion between 2000 and 2012. The Senate report followed a whistleblower lawsuit by a demoted employee, which discovered evidence used in subsequent investigations.

The IRS proposes to tax as U.S. profits the amount earned from parts transactions by Caterpillar SARL in 2007-12, and the firm is contesting tax and penalties of around $2 billion for these years. However, because it has continued to file tax returns on this same basis, we believe the current exposure could be $3 billion, and we thus deduct this from our estimated fair value for all equity shares. Future tax rates could be greater if this Swiss segment continued to sell most international parts, given the mid-single-digit tax rate the firm enjoys on that operation. As a potential offset to this this, we expect the overall statutory rate is likely to decline beginning in 2018 if President Donald Trump can muster sufficient support for his corporate tax reduction initiative. We’re maintaining our corporate tax rate at this time.

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Keith Schoonmaker, CFA does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.
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