Can Caterpillar Meet Its Full-Year Guidance?

| About: Caterpillar Inc. (CAT)

Summary

Caterpillar’s Q1 projections were well below consensus forecast.

Q1 results highlight the challenges CAT faces in its end markets.

Although the company has maintained its full-year guidance, a downward revision looks likely based on Q1 results.

Caterpillar (NYSE:CAT), last week, gave a weak guidance for the first quarter. The weaker-than-expected earnings and revenue forecast by CAT highlights the challenges the construction and mining equipment maker is facing in its end markets notwithstanding the recent rally in commodities. Interestingly, CAT maintained its full-year earnings and revenue guidance. That was the reason perhaps the stock rallied despite the weak Q1 guidance. However, CAT's projections for the full year are far too bullish especially given the weak fundamentals in all of its end markets.

Q1 Disappointment

Caterpillar will release its Q1 results on April 22, 2016. But last week, the company gave an idea of what to expect. And the news was not good for CAT longs, including this author. The Peoria, Illinois-based company expects Q1 earnings to be between $0.65 per share and $0.70 per share. This is well below the consensus forecast of $0.95 per share. CAT expects Q1 revenue to be between $9.3 billion and $9.4 billion. This is again well short of consensus forecast.

The disappointing Q1 numbers do not come as a surprise though. In fact, in my last article on Caterpillar, I had noted that the company might struggle to meet its revenue expectations for 2016.

Indeed, CAT's performance will have improved significantly if it has to post results in-line with its guidance range. The company's earnings guidance for 2016 is currently at $3.50 per share. Revenue has been projected at $42 billion ($40 billion to $44 billion range). Given the Q1 results and the state of most of CAT's end markets, meeting those expectations looks like an uphill task.

End Markets to Recover?

The fact that CAT has reiterated its full-year guidance implies that the company expects market conditions in the second half of the year to improve significantly. None of CAT's end markets though are showing signs of a sustained recovery. It is true that sentiment has improved somewhat in the oil markets since the start of this year amid talk of production freeze. But the oil market still remains oversupplied. Also a recovery in price does not translate into higher capital spending from oil & gas companies immediately, which is what CAT needs to improve its financial performance. The company faces the same issue in mining where commodities such as iron ore and copper have seen a recovery but a rebound in capital spending is unlikely in the short-to medium-term. So essentially the state of CAT's end markets remains same. Given this scenario, I expect a downward revision from CAT sometime this year.

Are Dividends Safe?

In my article on Caterpillar last month, I had discussed whether the company's dividends can be sustained in the present environment. Remember that CAT has an excellent track record when it comes to dividend payments. Even at the peak of the financial crisis, the company had raised its dividend. The question is whether weaker-than-expected results in 2016 have any impact on CAT's dividend payments.

In the previous article, I had looked at CAT's payout ratio between 2006 and 2015. In this ten-year period, CAT's payout ratio averaged 0.44. However, in 2015, the payout ratio was double the average of the ten-year period. CAT would have the same payout ratio in 2016, if it does not raise dividend and its earnings come in-line with expectations. Based on Q1 results, that seems unlikely now. If CAT's earnings come in at mid-point of the Q1 guidance range, the company's earnings will have to average roughly 94 cents per share over the next three quarters to meet full-year guidance of $3.50 per share (including restructuring charges). Given the huge miss in Q1, there is a strong chance that CAT will struggle to reach 94 cents per share in each of the next three quarters. If earnings remain at the same levels as seen in Q1, full-year earnings will total $2.70 per share. That would mean a payout ratio of almost 1.15. Remember in 2009 during the financial crisis, CAT had a payout ratio of 1.18. Market conditions were a lot worse then than they are now. So it is unlikely that CAT will announce a dividend cut anytime soon. However, sustained weakness in its end markets will force CAT to rethink its shareholder distributions.

Disclosure: I am/we are long CAT.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.