Target price slashed by 26% overnight! Morgan Stanley: The AI myth of Caterpillar (CAT.US) is being punctured bit by bit by the cycle.

In its latest research report, Morgan Stanley sharply cut its target price for Caterpillar (CAT.US) from US$915 to US$675, explicitly concluding that the stock has formally shifted from AI-theme-driven valuation expansion into a "cyclical valuation correction" phase. Although Morgan Stanley maintained its "Equal-weight" rating and "Attractive" industry view, it said outright that the market had long priced the stock for "perfection," leaving little room for error, with the new target price implying only about 4% upside. Caterpillar's third-quarter results slightly beat expectations and full-year guidance was maintained, but the stock still plunged 9.25% that day. AI sentiment had driven its shares to repeated record highs earlier this year, and Morgan Stanley believes three points are key: First, orders declined sequentially. Third-quarter orders were about US$25.6 billion, down about 11% quarter on quarter and significantly below buy-side expectations of more than US$29 billion, intensifying concerns about "peak earnings." Second, results and guidance were weak. Weighed down by manufacturing costs and inflationary pressure, third-quarter results and fourth-quarter guidance slightly missed expectations. Morgan Stanley cut its fourth-quarter EPS forecast from US$7.59 to US$6.39, its full-year 2026 forecast from US$28.38 to US$27.24, and its 2027 forecast from US$33.22 to US$31.49. Third, destocking in the construction industry. The company lowered its Construction Industries (CI) outlook, with fourth-quarter dealer destocking expected to be close to US$1.6 billion, above the previously expected US$1 billion. Notably, Morgan Stanley had previously explicitly warned of two major downside risks: doubts about the sustainability of the data center power generation equipment cycle, and more severe destocking in the construction industry. Now these two risks are materializing one by one, pushing the stock into a correction. By segment, the Resource Industries (RI) segment benefited from favorable price realization, with both revenue and margins revised up; Power & Energy (P&E) revenue was slightly revised down; and Construction Industries (CI) came under pressure from destocking, with its fourth-quarter operating margin expectation cut by about 318 basis points. On valuation, the new target price is based on 21.5x 2027 EPS, which Morgan Stanley calls a "cycle-top-on-bottom" valuation, compared with a historical forward P/E range of 11x to 22x. The previous US$915 target price was based on a multi-stage growth DCF under a "what you need to believe" framework, assuming an 8% sales CAGR from 2025 to 2030, which was already "no easy feat." Morgan Stanley expects the stock to trade in a US$550 to US$800 range over the medium term. However, the bank is not yet downgrading the stock to "Underweight" for three reasons: the shares have already retreated about 40% from their all-time high of US$1,073; orders, while possibly peaking, remain solid with no major cancellations; and the company's abundant free cash flow can support the share price through buybacks.