Caterpillar Inc. (CAT) reported its fourth quarter earnings on January 27th. Caterpillar is a leading earth-moving machinery and construction equipment manufacturer with an asset base of $8.94 billion as of year-end 2013. This report discusses the recent quarter's results as reported by the company, the improvement and deterioration of various segments, and the company's future outlook.
Fourth Quarter Performance Vs. Analyst Expectations
Although the financial position of the company has improved, as depicted by its higher cash flows from operations and a lower debt to capital ratio, the fourth quarter revenue base declined by approximately 10% compared to last. However, analysts were expecting a steeper decline of approximately 17%. A lower decline in revenues indicates a better than expected performance on the part of the company. In annual terms, however, Caterpillar's revenues declined by about 16% owing to the weakening mining industry.
The total revenues of the company are split into four major segments: construction industries, resource industries, power systems, and financial products. Resource industry has remained a major contributor to the revenue base of the company over the recent years. However, changing industry trends and shifting demand has made the future uncertain for the company.
Geographically, the company extracts 69% of its revenues from international sales and only 31% of sales are generated from the US. China is a major contributor to the international sales of the company accounting for about 6.3% of the total revenue base. Even though the sales generated from the Chinese market escalated by 20% the overall contribution from the market indicates a decelerating trend due to rising competition from the domestic manufacturers in China. In addition, revenue from the Asian market declined by 30%.
Looking at the revenue generated from different segments the plummeting sales figure was mainly due to the mining equipment industry contraction and this largely affected the overall sales of the company under consideration. Sales generated from this segment showed a morbid decline of 48% compared to the sales figure of last year. This slump was partially offset by a double digit growth (20%) experienced in the construction segment.
With regards to the net income figure, the profit base of the company remained positive but slumped by a steep 33% compared to last year's profitability. However, when you look at the recent quarterly performance of the company (2013), Caterpillar's profits grew at a CAGR of 4% despite the weaker demand for mining equipment. There were two reasons for the increasing profits:
- The strong performance of the construction segment
- Caterpillar aggressively reduced its operating costs over the past year by slashing its employee count by 6.8% and shutting down a number of its plants in several locations
With regards to the per share earnings reported by the company, Caterpillar exhibited an astounding 48% increase compared to the fourth quarter of the last year. The inflated figure is artificial, however, since the company wrote off an acquisition in China last year. After making the adjustment for this non-recurring event and the tax benefit received later on the rise after the EPS was reduced to just 5%. The company reported an EPS of $1.54 against analysts' expectation of $1.27 for the fourth quarter that ended in December.
With regard to the financial condition of the company, Caterpillar has reduced the level of its outstanding debt significantly as indicated by its debt to capital ratio that stood at 37.4% last year against the current level of 29.7%. Further backing for the strengthening financial standing of the company was indicated by its rising CFO. Caterpillar's cash flow from operations grew at a CAGR of 93% over the past four quarters and this elevated the CFO level significantly compared to last year. The increase in the CFO is explained by the following reasons:
- Increasing sales revenue from the machinery and power segment accounted for 89% of the CFO
- Strengthening construction segment
- Lower operating costs due to reduced workforce and plant shutdowns
- $2.9 billion inventory reduction
Caterpillar has been distributing cash among shareholders through its continuous share repurchase program for some time now. The company had a prior authorization to repurchase $7.5 billion shares, a goal which is expected to be achieved by March 2014 much earlier than the scheduled deadline of December 2015. Over the past four quarters of 2013 the company has reduced its total number of outstanding shares at a cumulative rate of 3%. To add to that, Caterpillar increased its dividends per share by 15% since last year. The company has maintained a history of distributing cash dividends among the shareholders of about $2.40 per share yielding about 2.60-2.80% per year.
To combat the weakening demand from the mining industry the company has shut down various plants and this has also led to a decrease in its workforce. The company has cut down its reliance on the mining equipment segment since it is hard to estimate the duration for which demand will remain low in this segment. However, the situation might change in the future as the emerging markets are expected to follow a high growth trend and developed economies like the US and Europe are anticipated to recover from the recessionary phase. That being said emerging markets are projected to grow at a rapid pace of 5.1% whereas the developed markets are projected to grow by 2%. This will lead to a higher sales figure for the company in the future.
Slower but continued growth of 5% in the building and construction segment is expected to be realized by the end of this year. Sales from the mining equipment segment are expected to suffer a contraction by about 10%. The overall sales figure is expected to remain rather stagnant.
Moreover, with the earnings release of the quarter that ended on December 31, 2013, the company made an announcement that it has received a board authorization to further repurchase shares worth $10 billion increasing the distribution of cash flows among shareholders.
Even though Caterpillar has beaten analysts' expectation and its stock price has appreciated since the earnings release I would not recommend investing in the stock because there is more downside risk than upside potential. For one, the sales figure of the company has declined by 10% since last year. Even so, I believe that the sales figure for this year is still artificially inflated by inventory sales and other cost reduction operations. Secondly, although the emerging markets are expected to show high growth in the upcoming future, competition from domestic manufacturers is rising and this will probably lower the revenue generated from these markets. This trend is particularly apparent in China. Thirdly, the company is still heavily reliant on the mining equipment segment, the demand from which is expected to decline even further this year.
Even though the company is heavily distributing cash among its shareholders through dividends and share repurchases the future profitability of the company seems dim.