Caterpillar's (CAT) quarterly results pretty much revealed what many investors were already expecting: ongoing sales declines. Caterpillar reported fourth quarter 2013 revenues of $14.4 billion which compares against $16.1 billion in the fourth quarter of 2012 (a decline of 10%). The decline is solely attributable to Caterpillar's Machinery and Power Systems division whose sales declined to $13.6 billion from $15.4 billion a year ago (down 11%). However, Caterpillar achieved a respectable turnaround in profit in spite of challenging macroeconomic conditions: The equipment company delivered earnings of $1.0 billion which compares against $697 million in Q4 2012. Caterpillar's diluted EPS came in at $1.54 and compares against $1.04 in the fourth quarter of 2012 (an increase of 48%).
Caterpillar also reported full-year 2013 revenues of $55.7 billion vs. $65.9 billion in 2012 (a decline of 16% which was driven by slowing global mining activity). Earnings fell 33% to $3.8 billion vs. $5.7 billion in 2012 and Caterpillar's diluted full-year EPS slumped 32% to $5.75 from $8.48 a year earlier. Despite falling sales and a contracting mining sector, Caterpillar still achieved record operating cash flows of $9.0 billion in its equipment division boosted by a $2.9 billion decline in inventory.
Strong cash flow generation leading to share repurchases
One of the most notable characteristics of the company is its focus on shareholder remuneration. Even though Caterpillar took an almost $10.2 billion hit in sales in 2013, the company repurchased $2.0 billion worth of common shares during the year. Caterpillar also announced two more nuggets for shareholders: First, Caterpillar intends to repurchase another $1.7 billion worth of common stock during the first quarter of 2014. Second, the company announced a new $10 billion stock repurchase program which was approved by the Board of Directors. Share repurchases come in addition to a regular cash dividend which Caterpillar hiked by 15% to $0.60 per share in 2013.
Ongoing restructuring costs and outlook 2014
2013 wasn't a good year for Caterpillar as well as the mining sector in general. A slowdown of the Chinese economy, a vital driver for global commodity and construction equipment demand, has led to significantly lower sales for Caterpillar's mining products. Caterpillar now expects approximately $56 billion in sales in 2014 which is about the same level as in 2013.
2013 was also a year of restructuring for Caterpillar which included tackling structural costs, facility closures, downsizing and layoffs. Caterpillar still expects about $400-500 million in restructuring costs in 2014 which brings estimated 2014 earnings per share in the neighborhood of $5.30.
In the short term, investors are likely to focus on Caterpillar's sales development. Improving economic conditions, especially in China, and rebounding equipment sales could be a powerful catalysts for Caterpillar's stock price.
Trailing twelve month share performance
Caterpillar's high reliance on the mining sector and exposure to the construction business in China has taken a toll on Caterpillar's share price in 2013. Most notably, Caterpillar was thrown under the bus as renowned shortseller Jim Chanos from Kynikos Associates disclosed a Caterpillar short position in July 2013.
Caterpillar's heavy dependence on China has caused the return differential between Caterpillar and other construction equipment manufacturers to widen in 2013. Cummins (CMI) gained 20% over the last two years while AGCO (AGCO) returned 3%. Deere & Company (DE), a long-standing equipment manufacturer with a focus on farm machinery, lost 1% while Caterpillar lost 15%.
Caterpillar trades at just above 16 times forward earnings which makes it the most expensive company in the peer group of construction and farm equipment manufacturers. However, earnings and sales expectations for Caterpillar appear to be quite pessimistic and investors are usually hesitant to purchase a stock unless they see some meaningful improvements in the underlying profitability. I think that Caterpillar has interesting rebound potential when analysts update their earnings outlook which should give Caterpillar's shares tailwinds particularly if China's real estate and construction sectors gain momentum.
Caterpillar pays investors $0.60 per share in dividends which equates to a dividend yield of 2.56%. The company has an extraordinary shareholder remuneration record stretching back well into the 1920s and which creates confidence that management will keep its implicit promise of dividend continuity. Caterpillar also has the highest dividend yield in the construction- and farming equipment manufacturing sector.
The table below summarizes the results for Caterpillar as well as the peer group and depicts the premiums to the P/E, P/S and D/P ratios the company trades at.
While 2013 was a bad year to be a China-focused mining equipment manufacturer, the company should get credit for achieving record operating cash flow in its important Machinery and Power Systems segment. Also, the company has counteracted the cyclical decline in high-margin equipment sales with deep-cutting cost savings programs that helped Caterpillar become a leaner company which will serve Caterpillar well when the Chinese economy rebounds. In addition, Caterpillar is extremely focused on delivering value for shareholders via extensive share repurchase programs. The announced $10 billion share buyback program is likely to provide good support for Caterpillar's stock price.
Caterpillar is a good investment for contrarian investors who believe that the company has already found its bottom. I think Caterpillar's stock will react very positively to better Chinese economic data and its share price will probably recover before the company announces an uptick in equipment sales. Anti-cyclical investors who think Caterpillar's sales will benefit from higher Chinese growth in the coming years should consider an investment in the construction equipment company. Contrarian long-term BUY.