Shares of Caterpillar (NYSE:CAT) jumped over 6% Monday morning after reporting quarterly results that blew past analyst expectations (press release available here). Even after this pop, shares are still down 3% over the past 12 months, missing out on one of the strongest rallies in the S&P 500 in years. The company also announced it intends to buyback $1.7 billion in the first quarter, which will complete the existing authorization. As a consequence, the board approved a new $10 billion authorization. While this figure is large, the authorization lasts until 2018. Still, the plan is nothing to complain about. Caterpillar's performance was impressive, but I would not buy shares on this rally due to continued headwinds in its business.
In the fourth quarter, Caterpillar earned $1.54 on $14.4 billion in revenue compared to expectations for $1.28 on $13.6 billion. While these numbers blew past expectations, sales were down year over year by 10% while earnings ex-items were helped by cost cuts and increased $0.08. For the full year, sales were down 16% to $55.66 billion, which cut earnings by 31% to $5.75. CAT's challenges are driven by weakness in its mining unit as gold and copper prices were under pressure while its power systems unit continued to grow. The only qualm with this quarter is that the company has a declining backlog, which is to be expected with declining revenue. The company has offset some of these challenges with a $1.2 billion cut to SG&A and R&D expenses, driven by a 9,703 reduction in headcount.
Asia continues to be a major headwind due to reduced mining activity. Sales were down 30% in the region. While sales were up 20% in China, this figure was driven by a need for dealers to increase their inventory rather than better demand. Thanks to lower gold and iron prices, Latin American sales were down 20%. With its focus on mining equipment and construction machinery, Caterpillar is very exposed to emerging markets, which have faced some challenges of late. Unless emerging markets start to accelerate, CAT will continue to face difficulties.
In the quarter, CAT's mining unit saw a 48% decline in revenue. Many miners have high debt loads and are being forced to cut cap-ex amid lower end prices. The decline in 2014 will certainly be less steep than in 2013, but I expect mining to be sequentially lower. Companies like Freeport-McMoRan (NYSE:FCX) have promised shareholders it will cut its cap-ex budget by over $1.5 billion, which means it won't need to buy as much equipment. Gold miners have been particularly austere as a lower end price have changed the feasibility of some projects. After multi-billion write-downs, Barrick Gold (NYSE:ABX) and Newcrest have suspended projects with Barrick mothballing its Pascua-Lama project, which had promised significant growth. While gold-centric miners are retrenching the most, even diversified giants like Rio Tinto (NYSE:RIO) and BHP Billiton (NYSE:BHP) have promised to cut their spending.
With lower cap-ex budgets, Caterpillar's mining revenue will continue to fall. CAT's business is really at the whim of cap-ex budgets, which are determined by end prices. Unless copper consistently trades above $3.75 and gold moves past $1,350, expect cap-ex budgets to be tight. While Caterpillar is benefiting from improvements in construction and power, mining continues to be a major headwind for results.
Caterpillar also offered guidance for 2014, which hopefully is more realistic. Over the past 18 months, management had been overly optimistic and consistently over-promised. In the last two quarters, that optimism has abated, and hopefully this guidance is more reasonable. The company expects to generate the same amount of revenue as it did in 2013 (plus or minus 5%). Excluding continued restructuring costs as CAT continues to cut costs, it expects to earn $5.85 up 1.7% from last year. CAT expects a mild decline in mining offset by a stronger performance at the construction and power units.
Shares of CAT are trading at 15.6x 2014 earnings and do sport a solid 2.6% dividend yield. However, I continue to think there is more downside risk than upside risk to CAT's guidance due to lower cap-ex budgets and increased competition in China from Chinese machinery manufacturers. The Chinese government has been encouraging firms to buy from domestic suppliers, and Chinese firms have been able to improve the quality of their products. If CAT faces appreciably stiffer competition in China, EPS could end closer to $5.50-$5.60 in 2014. With volatile end markets and an unimpressive track record over the past three years, I wouldn't pay more than 13x earnings or $71-$76. Investors should take advantage of this rally to sell shares at an inflated price.