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Caterpillar, Inc. (NYSE:CAT)

Deutsche Bank 2014 Global Industrials and Basic Materials Conference Call

June 04, 2014 04:00 PM ET

Executives

Richard Moore - Director of Investor Relations

Michael Hollen - Manager of Investor Relations

Analysts

Unidentified Analyst

Hi, good afternoon everyone. Welcome back. I have today with us one of the leading industrials commemorate Caterpillar; with us is the Director of Investor Relations, Richard Moore as well as the Manager of Investor Relations Michael Hollen. We're going go through a couple of slides first and then we're going to open up for Q&A. So with that, Rich?

Richard Moore

We need to start with this slide. Hope everybody can read that. Today we will be discussing forward-looking information that involves risks, uncertainties and assumptions that could cause our actual results to differ materially from the forward-looking information. Additional information concerning the factors that could cause our results to materially differ can be found in the Risk Factors section of our Form 10-K filed with the SEC and the forward-looking statements contained in this presentation.

Okay. We released our first quarter earnings about six weeks ago so I am just going to spend a few minutes to remind everybody of our results. In general, we're very pleased with our operational performance sales and revenues were flat versus a year ago at $13.2 billion. We're showing profit per share two ways both with and without restructuring charges. Now profit per share excluding restructuring was $1.61 and with restructuring charges was $1.44 versus a $1.31 in first quarter of 2013. And we’re very pleased with these results.

When you think about it we achieved flat sales performance or I am sorry we achieved this positive performance on flat sales and with the breakdown of the sales was quite different versus a year ago. Our Construction Industries was up 20% it was our largest segment in the first quarter. Energy and Transportation was up 8%. But our Resource Industries which is mainly mining was down 37%. So, it’s really strong performance with one of our historically highest margin businesses down that much in the year.

Looking back to 2011, you can see the peak in 2012 that about $56 billion in sales and revenues and $8.48 in profit per share. And then the significant drop in 2013 to about $56 billion and $5.75 per share. That’s $10 billion off the top-line with the majority coming from mining. But we’re confident that mining will come back and as we said many times before we just don’t know how soon.

For our 2014 outlook, we held sales and revenue forecast flat at about $56 billion plus or minus 5%. In our first quarter release we reduced our Resource Industries segment from down 10% to down 20%. But our Construction Industries segment is looking a little better and we increased our outlook from up 5% to up 10%. And we’ve kept our Energy and Transportation outlook unchanged at up 5%. And based on the strong operational performance in the first quarter we’re very pleased to raise our profit outlook for the year by $0.25 a share.

So as you can see excluding restructuring our profit per share outlook is $6.10 and including restructuring charges it’s $5.55.

This quarterly profit per share chart gives a good perspective of where we were a few years ago and the significant decline in profit in fourth quarter of 2012. But we’ve gradually covered and are building our profit per share back up nicely over the past five quarters.

And as we highlighted in our first quarter release, while we're very happy to raise our profit outlook for 2014, there are a lot of risks and uncertainties around the world, and we remain concerned and very focused on these issues. We hope Russia and Ukraine come to a peaceful and satisfactory conclusion and we're watching this situation very closely.

In China, we had a nice quarter, up about 30% versus last year. As this country transitions to a more sustainable growth model, there may be challenges and setbacks along the way. W0e're keeping a close eye on how this progresses and the impact it may have on the economy.

We understand we don't control economic uncertainties and we're focusing instead on what we can improve. We've lowered cost, improved cash flow and are driving value through our lean manufacturing initiative. Because of this, even with sales and revenues flat with a year ago, our profit increased.

Now, to wrap it up, I'd like to point out a few highlights from the first quarter. We rolled out our updated enterprise strategy at our Annual Leadership Summit and worldwide dealer meeting in February. It’s a strategic update, so we're not making any major changes or going down a different path, but we're making a few adjustments to better position us for the next five years.

We named sustainability as our fifth corporate value alongside commitment, integrity, excellence and team work. We have a very broad definition of sustainability from recycling and eliminating waste in our factories, to product innovation and technologies that better serve the needs of our customers and also the support and volunteerism our employees provide to local communities. We are very proud of the progress we made in our sustainability journey. We also rolled out our Across the Table initiative which is a tremendous opportunity.

Now this is a broad initiative with our dealers to raise the bar and performance and consistency. Now we updated our progress on our lean transformation which is really starting to be a good traction in our factories and in our offices as well. We had a very successful show at CONEXPO in March, where we highlighted technologies that really help customers lower operating cost and improve efficiency.

And again just to recap our financial and operational performance, on flat sales, our profit per share was $0.29 better than our first quarter of 2013 excluding restructuring charges. We had excellent cash flow of $1.9 billion, raised our 2014 profit per share outlook by $0.25 and we repurchased $1.7 billion in stock. So all-in-all we feel it was a pretty good quarter.

So with that [Vish], I will stop here and we can go into the Q&A.

Question-and-Answer Session

Unidentified Analyst

Thanks Rich, yes. So I guess maybe we can just start off with the diesel Resource Industries segment and some of the data that we’ve seen recently from dealer sales suggest that Resource Industries sales are down, here today it’s about 40% year-over-year versus your guidance of down 20%, so it would imply a significant ramp in the back half of the year. Can you talk about what you are seeing right now to guide to that kind of an improvement, is this going to be mostly inventory restocking and can you just talk about some more details on that?

Richard Moore

Yes, maybe a couple of points of clarification to better frame that. The retail statistics typically call maybe the dealer stats that you see every month that is just OE which is original equipment. Our guidance for the year would includes parts as well and just to frame that a little bit if you think about the delta the change from 2012 to 2013 and to where we are currently and the majority of our change in our resources industry segment has primarily been OE. Aftermarket has been relatively stable during that period so the percentage of the total that’s now parts compared to OE part is a much higher percentage of the total. So if you think about the retail stats again primarily OE and how much that’s down it’s not very fall off the line with what the guidance is for the full year. [Technical Difficulty] anything more.

Unidentified Company Representative

I guess what I might add to that is as [Technical Difficulty] as we think about the first half of 2013 our sales [Technical Difficulty]. So if you look at the delta for example in Asia Pacific it shows us off 70% well during the period of time in 2013 we are actually selling quite a lot of products still to them from the dealers to the end users. So our sales came down quickly in 2013 but as the dealers worked down their inventory took a little longer before that caught up.

Unidentified Analyst

So on the inventory destocking at dealer level are you still seeing that continue in the second quarter, do we expect that in the third quarter as well or you are going to stop seeing some sort of a rebuild and some rationalization in the third quarter?

Richard Moore

Yes. In resource industries we still do have and particularly in one particular case we still have some excess dealer inventory out there that will continue to work down through the year. But other than that inventories as Matt mentioned throughout 2013 dealer inventories came down quite a bit and for the most part are kind of inline with the end user demand at this point.

Unidentified Analyst

So can you talk a little bit about just some of the demographics that you are see in recent industry levels, what are the utilization rates as some of the fleets out there, what is the average agency that you are seeing right now versus a year ago?

Richard Moore

Yes. We commented at CONEXPO as an example that we believe that there may be about 10% to 15% of idle capacity [become parked] fleets out there. The mining companies started to cut their CapEx in 2012 and even more so in '13 and here that's going to continue. Again the primary objective really on the mobile equipment side of CapEx, this CapEx includes a lot more than just kind of equipment that we sale. But clear objective is really to get that fleet utilization up, they had excess capacity and mining vehicle let's say.

And we think they've been doing a good job of getting that utilization up, so that [some of them] focused on and we think they are making good efforts on that, some of the tactics that we believe they have been using as we've talked about before whether maybe idling some of the older machines putting more hours on the newer machines that will buy them some time on some of the rebuilds and maintenance push outs that we know is going on, so that's all, that's [Technical Difficulty].

Unidentified Analyst

Okay. That's helpful. In terms of your position within the mining equipment space what do you think your market share is today versus some of the Chinese competitors that seem to be at least talking about gaining market share. Do you see that happening and how do you see the market share evolve over the next cycle?

Richard Moore

Yes. We don't really see much change in market share currently, certainly with the Chinese competitors [Technical Difficulty]. We know there are some [opportunities] they have some of the mining side [Technical Difficulty] whether looking at testing some of those issues [how] they perform I think the bigger thing to think about those with our business models is the dealer support, that’s a big part of the equation and that’s something that’s not easily replicated when you look at the high demanding product support and services that dealers provide that it goes lot beyond just having product in the field. So, while we’re keeping our eye on all competition and making sure that we need to do to maintain our high market share. Right now we don’t see that as a big change or big threat in the near-term.

Unidentified Analyst

Yes. When you look at some of the mining customers financial then just a real fundamental it sounds like a lot of things are not getting worse at least the cash flow situation is getting better, pricing environment seems to be better for them. So, at some point you should start seeing a recovery in your orders and do you see that happening in the back half of this year you think or it is going to be more in 2015…

Richard Moore

That’s the magical question everybody wants to know including mine customers themselves. I think what their plans are, certainly we’re not going to make a prediction on when that’s going to happen. Certainly the fundamentals if you look at what drives equipment demand and whether that’s OE or aftermarket, it’s mine production it’s the age of the fleet, it’s how many hours on the fleet, the rebuild cycles and all of that would tell you that some of the tactics they have used as I mentioned before at a limited time that they have to eventually get back into the rebuild, the maintenance and eventually the replacement cycle. Because again the fact is that mine production continues to perform pretty well, it’s up year-over-year expected to be up going forward. So the fleet utilization is rising. So all of that would indicate that it’s a matter of time we just don’t know exactly what it is going to happen.

Unidentified Analyst

Moving on to margins, as you think Resource Industries margins, they have been in the mid single-digit range. Do you expect any further restructuring actions? And where do you think the margins look like as you go into the back half of this year or next year?

Richard Moore

Yes, margins for Resource Industries in the first quarter were single-digits. And unless there is a meaningful improvement in sales and production of OE, equipment and parts, we'd expect margins to remain at that level.

So, as we think about margins for Resource Industries, we would expect that in normal production levels for them to be in to mid to upper double digits and up around 20%. But where we're operating at today, I think the margins that we have today would be what we should expect for the next few quarters.

Unidentified Analyst

And any further restructuring actions that you think would be required in light of some of the solution data and…

Richard Moore

They are always looking at what other things they need to do to get the cost structure in line. There has been some other announcements recently, some production employees that have been released from some of our facilities. So, they'll continue to do that to get the right cost structure in line with the production levels. But a lot of that took place last year and some of the benefits that the mining group is seeing, come through this year to get back to the margin question. There is also a lot of spend, R&D spend in other program, engineering programming spend that we talked about in the past that we really need to get working on that has a really nice long-term pay out and that's things like engineering, Cat components into the form of Bucyrus product, it's investing in the parts logistics to support to support the new Bucyrus products that are now in the field with our dealers. So those activities, we needed really cut that back quite a bit last year, and now I think where we need to get back into the investment side on that, that will offset a little bit of the savings we had from the restructuring from last year.

Michael Hollen

And I might add to that too. If you think about the restructuring activities that we read in 2013, took out [layers] management, we consolidated small facilities and moved some of that production to other facilities that were existing but the production of the large machines for most of the large mining products is done in a sole source. And so we got assembly lines that we’ve scaled with people, let’s say into (inaudible) plant, the next large mining trucks. But to take further restructuring actions to let’s say shut a facility or shut a production line wouldn’t make much sense as we do expect that production lines will return at some point.

Unidentified Analyst

Okay. I know you just raised your outlook for construction sales this year, and can you talk about how you are seeing construction fundamentals regionally, which regions you think, you said North America appear to be stronger than expected and was that mostly of the upside?

Richard Moore

Yes. We are going to make and exclude North America, there is not going to be a whole a lot to talk about. That’s primarily what drove our outlook improvement; the U.S. market in particular looks to be on better footing and continues to improve albeit at a modest pace. We are still -- industry is still 20-25% off of the peak of 2006, so there is still plenty of runway left to improve. But we do see the fundamentals and some of the improvement playing through. So that was really the driver of our outlook change but going around the world, Europe is also looking a little bit better in select countries the UK, Western European countries, our business is starting to look a little bit better there. Dealers are restocking a little bit and prepare for some improved business. So that’s a good sign coming off a very low base but it’s good start. The rest of the region that we have Europe, Africa, Middle East outside of Western Europe is still I think not showing a whole lot of signs of improvement yet but certainly CIS is challenged right now with what’s going on with Russia and Ukraine. So that’s kind of Europe, Africa, Middle East region.

And then in Asia primarily China, we are seeing as we’ve all seen some of the data points out of China that that industry is looking like it’s slowing down a little bit, softening a little bit, we’re still performing pretty well, gaining share but that -- we’re watching that very closely as that economy as I mentioned transitions to a more sustainable growth model. There is things of development, efforts that we are taking to manage that economy that we have to watch very closely.

Unidentified Analyst

So if you think about any potential for further upside in the construction business, would that come from inventory restocking or will it come from just stronger growth in North American market and what do you think (inaudible).

Richard Moore

Well, I think upside would really come from a couple of different places, one absence of some of the concerns that we mentioned; things in the CIS come to a satisfactory conclusion. That would give the overall global economy probably a little bit better confidence; same thing with China; Brazil, there is some pockets of concern out there that if those things turn out to be a little bit better and less concerned that would help. I think in the U.S. there is still quite a bit of uncertainty about what’s going to happen with the highway bill and interest rate policy and tax policy. So I think some of those uncertainties that are out there in the U.S. as well if some of those get clarified or that will give confidence in the future and it will allow some upside potential there.

Unidentified Analyst

Okay. On the margin front where do you think the mix is between the two ultimate equipment and the compact equipment today and what do you think happens in the back half of the year or what happens in margins?

Richard Moore

Well, we had a pretty rich mix in the first quarter, in fact our construction industry’s margins were around 13.5%. A lot of that was based on the fact we have sold a larger proportion out of some of our higher profit larger machines like exhibitors. As we go into the remaining three months, we wouldn't expect that rich mix to continue. In fact we would expect that there would be a larger proportion of smaller machines, backhoe’s, skid steers, those types of equipment would satisfy the housing marketplace, that business is actually quite good today and the margins are a little bit less. And so that would affect our margins in the second, third and fourth quarter construction industries.

Unidentified Analyst

Okay. Moving onto the Energy and Transportation business. Can you just talk about your mix within oil and gas onshore versus offshore and some of the other end markets in that segment?

Richard Moore

Yes. We don't breakdown the end markets within oil and gas very specifically, because they change dramatically year-over-year, but just some color on what we're seeing there, the onshore drilling and pressure pumping area is an area that we see some improvement in, that's been down a little bit over the past couple of years and particularly last year. And so that looks like it's improving a little bit this year based on where natural gas prices are and the overall supply storage levels of natural gas is allowing some more drilling and activity in that segment. But the largest component of oil and gas that we serve is really the transmission or compression. If you look at the [reset] engines that we sale and then the turbines and natural gas compressors, that’s the largest area of natural gas that we participate in the compression.

Unidentified Analyst

So, are you seeing any changes in order trends within the OE and aftermarket business in that particular segment in engineering and transportation group overall?

Richard Moore

Overall Energy and Transportation or in oil and gas?

Unidentified Analyst

Overall E&T.

Richard Moore

Well it’s hard to talk about that, such a diverse segment, you almost need to go through the end markets and again I think oil and gas as we talked about some of the utilization of some of the equipments that’s in on the drill rigs, as that picks up that’s again high production harsh conditions that would fit more into a higher aftermarket type of application I must say a standby gen set would be. And in the power gen end market again it’s quite a bit different in aftermarket between a plan power application versus standby. But we are seeing a power generation improving a little bit. We have, expected that to be up year-over-year in line with kind of the overall Energy and Transportation segment.

Unidentified Analyst

Okay. Well at the beginning of the year you talked about the industrial business demand seem to be soft, but some of the data that you’ve seen so far from the dealer statistics that reported strong fundamentals in that segment. So, can you talk about what’s going on there, do you see any upside to get out within that portion of the business.

Richard Moore

Yes. The industrial end market, again just to remind everybody that's loose diesel engines that we sell through a whole host of OEM industries, ag, construction, power gen. And there was a -- in the back half of last year and particularly in the fourth quarter, we had a pretty strong sales ahead of emissions change in Europe predominantly.

And so while the year-over-year trends and retail statistics have been pretty good and we expect the comps to be quite a bit tougher as we get into the back half of the year, based on that pre-buy that we saw heading the last quarterly of the year.

Unidentified Analyst

Okay. So moving on to the locomotive part of the business, one of the concerns investors have expressed that you don't have a Tier 4 compliant offering. Can you talk about your plans there and when you think we should be expecting the back half of the year.

Richard Moore

Well, as in 2014, if I can start there, we expect to have actually a pretty good year of sales in locomotives to many of our North American customers, class one railroads.

As we go into 2015, the emissions laws change, we will have an emission, diesel emission compliant locomotive in the first quarter of 2017. So, people would ask what does that mean for 2015 and 2016.

Based on working with our customers in that segment, the customers have quite a strong loyalty to the current offering, they like an EMD locomotive, they like the 710 engine, it's been in existence for a number of decades and they like that engine quite a bit. So that's part of the rationale for why they are buying locomotives this year as to carry them through into ‘16 and ‘17. We believe that in ‘15 and ‘16 that they will be testing all products, competitors’ product and that they are looking for a couple of things. They are looking for a good diesel alternative that’s tier 4 compliant but they are also looking at other alternatives for powering their locomotives like natural gas. And so, we would expect to go do the testing both of these oil and natural gas offerings during that period of time and then we will be buying in ‘17 and beyond.

I think that the other question that people often ask is you are selling quite a lot of locomotives in North America this year, won’t that have a significant impact on sales for ‘15 and ‘16. And you really kind of have to start at the overall energy and transportation segment, about $20 billion in 2013, about 30% of that was related to transportation. So within the transportation segment, dissecting it further, you’ve got marine, you have got EMD locomotives but you also have Progress Rail which would be a rail, part of our rail business but it’s kind of below the track rail service, track works, met with the way equipment those types of things which make up a large piece of that.

So then within EMD, you have got sales of locomotive in North America, you have got sales of locomotives in the rest of the world, and then you have parts and service and support. So as this goes down, our expectation is although, we won’t be selling locomotives in North America, we will be selling them in other parts of the world and there will be regional opportunities that will augment that and support that as well. So the expectation is overall for E&P, although we haven’t done a forecast for ‘15 yet, there will likely be other things that will off some of the shortfalls of the sales of locomotives in 2015 and ‘16.

Unidentified Analyst

Okay. Well I guess in the interest of time, I can open up for questions from the investors. Anyone? I guess I will continue with my questions in that case. You still have about $10 billion remaining in your repurchase authorization. I know it’s hard to predict timing and all but can you just talk about what -- how you think your buyback program function -- mostly a function of stock price or what are some of the other things that you consider in cash flow, how you did last year versus your expectations for this year?

Richard Moore

Yes, and to just remind everybody, in 2013 we repurchased 2 billion of Cat stock; in the first quarter of this year we repurchased 1.7 billion. That finished out our prior authorization. At the same time, we received approval for a new authorization of 10 billion and that goes through the end of 2018. So we have five more years on that.

As far as the cadence that we expect, as you mentioned, it’s really hard to commit that and we don’t have a specific forecast on that. What we do, we have a pretty structured process that we review every quarter; it’s our cash deployment process and we look at the visibility we have in our business which is first and foremost and visibility of the cash flow obviously. And it starts with maintaining, ensuring we maintain a very solid balance sheet and credit metrics which right now that’s in very good shape. So, we don’t have much of an issue there. Then we look at our growth initiatives that would be M&A, capital -- CapEx, R&D, asset expansions things like that. Again we invested pretty heavily early on in the cycle, so we're in good shape on that item. A pension is the next pensions, and benefit plans in the next area of priority for cash. We're in very good shape there as well. So you kind of see how this process plays out. The last two items is really dividend increases which we expect to have kind of a sustainable but growing dividend each year. And then after all those other priorities to satisfy, it leaves cash to buy back stock.

And so while we don't have a specific forecast or prediction of what we're going to, how we're going to spend that 10 billion, as you go through that process, we don't expect to grow a cash forward on a balance sheet. So as we have both of this process, if we have access cash on our balance sheet and we look at the other priorities, then we will be returning that shareholders through buyback.

Unidentified Analyst

Okay. I guess the other question would be on. You talked about $9 billion to $15 billion of incremental revenue opportunity from the dealers, the timeframe for capturing some of that opportunity and what specifically you’re targeting, which regions and how do you think about getting there?

Richard Moore

Yes. And that's really related to the Across the Table initiative that I mentioned a bit ago that we build out in our strategy refresh in February. And what that is, that's a collaboration effort with our dealers to identify areas of their business where they might be underperforming and could improve through the use of benchmarking and best practice analysis. And so the $9 billion to $18 billion that we referenced at CONEXPO is really to frame the magnitude of the opportunity. It’s not really to set out quarterly or annual targets of how we’re going to progress toward the frame, again how important it is for us to focus on this initiative. But it’s things like rental, e-business, how dealers are embracing technology, how they’re covering the market, how many deals are they participating in. There is a whole host of metrics and areas that we’re going to be focusing on.

And to talk to the timeframe is by the end of this year, we expect to have the analysis of each dealer and identify the improvement initiatives that we’ll be working on with them by the end of this year for all the dealers. And then in ‘15, ‘16, and ‘17, this will be an implementation phase where we’ll work with them very closely to improve their performance in these various areas. And so by the end of that period of time ‘16, ‘17, ‘18 timeframe, we should have some meaningful improvements that we’ve seen. And it’s primarily driven by market share improvements. That’s how we kind of quantify the $9 billion to $18 billion.

And just to frame that, the $9 billion is reflection of if some of the underperforming dealers increase their performance up to the median of all the dealers and then $18 billion will be in the high end of that for the median to kind of be elevated as well. So, some of the better performing dealers, as they raise the bar and improve their performance as well, that’s just incremental upside on that initiative.

Unidentified Analyst

Okay. Any other question? Okay, thank you.

Richard Moore

Thank you.

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