Caterpillar - Little Appeal On Valuation And Leverage Concerns

| About: Caterpillar Inc. (CAT)

Caterpillar (NYSE:CAT) fails to catch a break. For the second time this year, Caterpillar is forced to lower its full-year outlook. Greater cuts in miner's capital expenditure budgets and reduced inventories from dealers are putting great pressure on revenues and earnings.

I remain very wary to invest in the shares as the current valuation is still quite rich. The company furthermore operates with a sizable leverage position, factoring in the financing activities of the firm.

Second-Quarter Results

Caterpillar generated second-quarter revenues of $14.62 billion, down almost 16% on the year before. Revenues missed consensus estimates of $15.09 by a wide margin.

Net earnings fell from $1.70 billion last year to just below the billion mark. Net earnings came in at $960 million, with earnings per share contracting by over 42% to $1.45 per share. Earnings missed consensus estimates of $1.70 per share.

During the quarter, the company bought back some $1 billion worth of its own shares. The company plans to repurchase another $1 billion of its shares during the current third quarter. Last month, the company raised its quarterly dividend by 15% to $0.60 per share, to soften the pain for its shareholders.

CEO and Chairman Doug Oberhelman commented on the developments, "Even though our sales and profit in the second quarter are down from last year, I'm pleased with how our team has performed. We've taken action to respond to the economic environment we find ourselves in, and operationally, the team has done a great job. We experienced headwinds during the quarter, and while we had a positive $135 million gain related to the Siwei settlement, it was more than offset by currency translation and hedging losses, an additional $1 billion of dealer machine inventory reductions and a decline of $1.2 billion in our own inventory."

Looking Into The Results

While headline results of a 16% fall in revenues looks really bad, there are softening conditions. Dealers cut their machine inventory by a billion during the quarter, compared to a $300 million expansion last year. These effects explain roughly half the total revenue declines. Divestitures and unfavorable currency movements shaved off a combined quarter of a billion in sales.

The most pain was felt at Caterpillar's Resource Industries business, which saw its revenues fall by one-third. Construction and Power sales fell by single-digit percentages. Worrying as well, Caterpillar saw revenue declines in each of its geographic regions.

The company already took steps and laid off some 13,500 workers compared to a year earlier. This excludes the impact of acquisitions and divestitures. Despite these steps, earnings fell off a cliff.

Construction earnings fell by roughly a half, while Resource Industries' profits fell by some 60%. Only Power earnings performed relatively well, falling by merely 3%.

Goodbye 2013 Outlook

On the back of the disappointing developments, Caterpillar has lowered its full-year targets. Annual revenues are now expected to come in between $56 and $58 billion, down from a previously guided $57 to $61 billion.

Full-year earnings per share are expected to come in around $6.50 per share, downwards revised by $0.50 per share.

The main reason behind the shortfall is a more significant reduction in dealer machine inventory. The company is already temporarily shutting down factories. It has also reduced its flexible workforce to accommodate the inventory shrinkage and poor conditions in the mining industry.


Caterpillar ended its second quarter of its fiscal 2013 with $6.11 billion in cash and short-term investments. The machinery and power business operates with a total of $9.5 billion in total debt. The financial unit of the company operates with over $30 billion in debt.

Revenues for the first six months of the year fell toward $27.8 billion. Net earnings fell to $1.84 billion, or $2.82 per share. This implies that Caterpillar expects to see slightly improving conditions in the second half of the year.

Investors are disappointed with the results. Shares fell some 3% towards $83 per share, which values the equity of the firm at $55 billion. This values the company at roughly 1.0 times 2013's expected revenues and 12-13 times annual earnings.

Caterpillar currently pays a quarterly dividend of $0.60 per share, for an annual dividend yield of 2.9%.

Some Historical Perspective

Despite the recent headwinds, long-term holders of Caterpillar's stock have benefited from the mining and agricultural boom over the past decade. While shares have been really volatile, they rose from $35 in 2003 to current levels of $83, while witnessing quite some volatility along the road.

This includes lows of $25 during the financial crisis and all-time highs, which were set around the $120 mark in 2011 and 2012. Shares have given up roughly a quarter of their value from that point in time.

Between 2009 and 2012, Caterpillar has more than doubled its annual revenues towards $65.9 billion. Net earnings roughly five-folded to $5.7 billion. Yet 2013's annual results will see a noticeable deterioration.

Investment Thesis

Caterpillar is having a terrible year. The company already cut its full-year forecast at its first-quarter presentation back in April, and is now forced to cut the outlook again.

While the company saw some green shoots at the time, the conditions kept deteriorating during the quarter. The backlog fell by another $1.3 billion on a sequential basis, to just $19.1 billion as miners continue to cut on capital expenditure budgets.

The good thing is that Caterpillar is really open in its communication to its investors. It provides a lot of information about the external environment as well in its quarterly reports.

While the headline numbers were terrible, roughly half of the declines are attributable to a reduction in inventories, totaling $1.2 billion for the quarter. Full-year inventory declines are expected to come in around $3.5 billion, compared to a $1.5 billion increase last year. This results in $5 billion revenue pressure on full-year 2013's results.

Yet there are some positive signs as well. Caterpillar is using the excess cash generation from inventory reductions to boost the pace of share repurchases to about $1 billion a quarter. This is after it recently hiked its dividend to comfort investors. Improved sales, and the impact from cost reduction measures should be seen in the second half of the year already. Compared to the second quarter last year, Caterpillar has already cut its workforce by some 8%.

As the long-term prospects for mining equipment remain rosy, Caterpillar should be able to survive this storm. Yet the current levels do not make it an obvious buy. Shares trade around 12-13 times 2013's earnings and it is not certain if 2014 will be better.

Also the significant leverage, especially from the financing activities, makes me a bit wary as well. While I am not joining Jim Chanos to bet against the company, as it was "tied to the wrong products at the wrong part of the cycle," I remain on the sidelines on valuation and leverage concerns.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.