Investors in Caterpillar (NYSE:CAT) are applauding an earnings beat for the final quarter, a more optimistic outlook for the world economy and a massive repurchase program. That being said, shares are not obviously cheap trading at 18 times expected earnings and roughly 10 times peak earnings as reported in 2012. I remain cautious, and stay on the sidelines.
Final Quarter Headlines
Caterpillar generated fourth quarter revenues of $14.40 billion, down 10.4% compared to a year earlier. Revenues came in far ahead of consensus estimates at $13.64 billion.
Despite the drop in headline numbers, earnings did see a meaningful beat. Reported earnings came in just above the $1.00 billion mark, up 44% on the year before. Diluted earnings rose by 48%, outpacing earnings growth on the back of share repurchases, coming in at $1.54 per share.
Adjusting for tax items and goodwill impairment charges taken last year, earnings improved by eight cents. Earnings comfortably beat consensus estimates after Caterpillar lowered expectations itself by lowering the guidance a while ago. Consensus estimates for the fourth quarter earnings stood at just $1.28 per share.
Diving Into The Results
Reported year-on-year declines of 10.4% in the fourth quarter of 2013 were significant, but are an improvement from the annual declines of 15.5%. A bit disappointing is the continued drop in the backlog, falling by $1.1 billion to $18.0 billion over the past quarter.
Gross margins improved by roughly 80 basis points to 26.8% of revenues. The company managed to show rapid cost declines in selling, general and administrative expenses as well as research and development costs. In this respect, Caterpillar remains very lean and pro-active with cost control.
Operating profits improved significantly to $1.45 billion, making up 10.1% of revenues which is up 360 basis points on the year before. Note that a great portion of these profit improvements are the result of pre-tax goodwill impairment charges taken in the final quarter of 2012.
Within the segments it was the resource industry having another very weak quarter, with revenues falling by 48% to $3.02 billion. Power sales were actually up by 5% to $5.56 billion while construction revenues accelerated by 20% to $4.85 billion.
The US is the best geographical area reporting a 6% increase in revenues to $5.36 billion. Europe, Middle-East and Africa revenues dropped by 9% to $3.49 billion, while revenue declines in Latin America and Asia-Pacific came in at 20 and 30%, respectively. What is important to see is the flexibility in Caterpillar's business model. All segments reported earnings, even the resource industry after reporting the steep revenue declines.
2013 In Review
2013 has been a very difficult year, but the final quarter and somewhat more bullish statements is creating hopes among investors.
Full year revenues dropped by 15.5% to $55.66 billion. The decline in earnings was much greater, with earnings falling by 33% to $3.79 billion. Diluted earnings per share for the year totaled $5.75.
While the earnings fall was severe, it was actually not that bad given the strong fall in revenues. Caterpillar reacted promptly, cutting its total headcount by nearly 10,000 over the past year to 133,300 workers.
Caterpillar is stepping up its repurchase activity, intending to repurchase $1.7 billion worth of shares in the first quarter, at a rate of 12.5% per annum.
These purchases will complete the current $7.5 billion repurchase program, but investors should not be afraid. The board authorized anew $10 billion repurchase program, expiring in December of 2018. The program is sufficient to retire roughly 18% of the outstanding share base, sending a strong signal to the market.
This payday came after the company reported record operating cash flows of $9 billion over the past year. Ironically enough, poor operating conditions which result in an inventory correction, provided much of these cash flows. Caterpillar notices that the debt-to-capital ratio fell to 30%, the lowest ratio in 25 year's time.
Total cash and equivalents stand at $6.1 billion while total industrial debt is $8.7 billion. This results in $2.6 billion in net industrial debt, while the financing unit holds another $25 billion in debt.
The current year is expected to be similar to 2013, with revenues seen around $56 billion. Restructuring costs will cost the company about $400-$500 million this year, or about $0.55 per share.
The company now foresees earnings of $5.85 per share excluding restructuring costs, and earnings of $5.30 per share when factoring in these costs. The guidance for full year earnings is seven cents ahead of consensus estimates.
Note that inventory reductions are most likely to end this year, although they might still take place in some mining areas. For 2013, Caterpillar itself nearly cut its inventory by $3 billion, while dealers lowered their inventories by a similar amount.
Implications For Investors
The report and outlook shows that Caterpillar might have seen the worst with revenues stabilizing and earning expected to improve. Note that earnings per share growth will be driven by expected share repurchases.
Even as circumstances in China were difficult, sales rose by 20% over the past year to $3.5 billion and a real pick up could boost overall results notably. Also note the other positive segments, in particular the very strong performance of the construction business over the past quarter, driven by the US housing recovery.
The lucrative mining business, remains weak. The strong cost cutting in the business combined with high margins results in real sales leverage potential if sales recover. Caterpillar boosted its exposure to this attractive segment with the ill-timed acquisitions. During the market highs it bought Bucyrus for $8.6 billion while it paid another $790 million for ERA Mining Machinery.
With worldwide economic growth expected to accelerate by a full percent point to 3% according to Caterpillar, the company has reasons to be more optimistic.
The jump towards $91 per share, still means shares trade at 17 times earnings for 2014. the strong payouts are comforting for to investors. The $0.60 quarterly dividend provides investors with a 2.6% dividend yield, accompanied by sizable share repurchases.
While recognizing the sales leverage potential, the current earnings valuation is still rather steep for a cyclical player, even if Caterpillar could match 2012 record results in 2015-2016.
I remain on the sidelines.