Target price slashed by 26% overnight! Morgan Stanley: Caterpillar (CAT.US)'s AI myth is gradually being exposed by the market cycle.

According to information from the Zhihui Finance APP, in its latest research report, Morgan Stanley has sharply lowered the price target for Caterpillar (CAT.US) from $915 to $675, clearly stating that the stock has transitioned from valuation expansion driven by the AI theme to the stage of a "cyclical valuation correction." While Morgan Stanley maintains its "Hold" rating and "Attractive" industry view, it frankly points out that the market has already priced the stock to a "perfect" level, leaving little room for error. The new price target implies an upside potential of only about 4%.

Caterpillar's third-quarter results slightly beat expectations, and the annual guidance was maintained, but the share price still plummeted by 9.25% on the day. AI sentiment had pushed the stock to record highs earlier this year. Morgan Stanley sees three key factors:

First, a quarter-on-quarter drop in orders. Third-quarter orders amounted to about $25.6 billion, down approximately 11% quarter-on-quarter and significantly below prior buy-side expectations of over $29 billion, intensifying concerns over "profit peaking."

Second, weak performance and guidance. Dragged down by manufacturing costs and inflationary pressures, third-quarter results and fourth-quarter guidance slightly missed expectations. Morgan Stanley lowered its fourth-quarter EPS forecast from $7.59 to $6.39, the full-year 2026 from $28.38 to $27.24, and 2027 from $33.22 to $31.49.

Third, inventory clearance in the construction industry. The company downgraded its outlook for the construction industry (CI), with dealer inventory reductions in the fourth quarter now expected to reach nearly $1.6 billion, higher than the previous forecast of $1 billion.

It is worth noting that Morgan Stanley had previously issued clear warnings about two major downside risks: doubts over the sustainability of the data center power equipment cycle and a more severe inventory clearance in the construction industry. Now, both risks are materializing, leading to a correction in the stock price.

Looking at different segments, the resources industry (RI) benefited from favorable price realization, resulting in upward revisions to both revenue and profit margins; power and energy (P&E) revenue was slightly revised downward; the construction industry (CI), pressured by inventory reduction, saw fourth-quarter operating profit margin projections cut by around 318 basis points.

On valuation, the new price target is based on 21.5 times the 2027 EPS, which Morgan Stanley describes as "peak to trough" valuation, compared to a historical forward PE range of 11 to 22 times. The previous $915 price target was based on a "what do you need to believe" multi-stage growth DCF, assuming a compound sales growth rate of 8% from 2025 to 2030—already a "difficult feat." Morgan Stanley expects the share price to oscillate between $550 and $800 in the medium term.

However, the firm has not downgraded the rating to "Underweight" for three reasons: the stock has already fallen about 40% from its all-time high of $1,073; orders may be peaking but remain robust with no major cancellations; the company has ample free cash flow, which can support the share price through buybacks.