While the key machinery end markets appear to be bottoming, manufacturing restructuring would likely drive “structurally higher margins” for companies like Caterpillar Inc. (NYSE: CAT) and Cummins Inc. (NYSE: CMI), Goldman Sachs’ Jerry Revich said in a report. He recommended a shift from construction products to machinery.

Caterpillar

Analyst Revich upgraded the rating on the company to Buy while raising the price target from $76 to $112. He believes Caterpillar would generate margin expansion in this cycle, which would drive $8 in mid-cycle earnings. This would be a result of:

• Reduction in the European footprint of construction industries.
• Resources footprint and product consolidation.
• R&D reduction.
• Capital allocation toward high-return product lines.

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Although the company’s shares have appreciated 30 percent year-to-date, versus a gain of only 6 percent in the S&P, the upturn reflects the recovery in key commodity prices. Revich added that the estimate of $8 in normalized earnings was significantly higher than investor expectations, and could result in “the next leg of upside for the stock.”

Cummins

The analyst upgraded the rating on the company from Neutral to Buy, while raising the price target from $134 to $162.

Cummins’ key end markets — including U.S., China and Brazil truck and power generation, mining and energy — appeared to have been bottoming. The company’s margins are much higher than the prior cycle trough, and there seems to be further upside to margins from the power systems manufacturing restructuring in 2018, Revich mentioned.

“We acknowledge risk from Navistar’s partnership with Volkswagen, but believe the risk is manageable (potentially affects 7 percent of EPS, 800 bps US market share) in the context of 28 percent upside to mid-cycle EPS of $11.50,” the analyst added.

At Last Check ...

• Caterpillar was up 0.9 percent at $89.01.
• Cummins was up 1.51 percent at $130.10.

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