The State Of The Economy: Check Out Caterpillar, Inc.

| About: Caterpillar Inc. (CAT)

Summary

Caterpillar, Inc. beat earnings expectations for the second quarter and this was hailed as a success; but Caterpillar's earnings were down substantially, year-over-year.

Caterpillar is facing a lot of things, like only modest economic growth in the US and in the world, and a great deal of uncertainty about the future.

Beating earnings expectations by a small amount is meaningless in such a world and putting so much attention on these expectations distracts from the bigger picture and management's actions.

One should not focus just on one company and claim it represents the state of the whole economy, but, the story being put out by Caterpillar, Inc. (NYSE: CAT) with its earnings report does seem to catch the mood in the business sector.

First of all, Caterpillar's earnings beat expectations.

Wow, should I be surprised?

Not really. Earnings guidance has become something of a joke, yet results always seem to emphasize the point that earnings have been exceeded. The article just cited contains the following sentence as the lead of its second paragraph: "Caterpillar topped second quarter profit and sales expectations."

And, responsible corporate leaders realize this and are starting to speak out about it. Earnings guidance has become a game, a game in which corporate leaders feel that they cannot fail to beat expectations, unless they have a large shortfall where they can then lump a bunch of stuff together and fail to meet expectations for just one quarter.

How many companies beat expectations by two cents…by four cents…again and again?

To me, the more important thing about Caterpillar earnings is not reported until the second from last paragraph of a moderately long article.

The paragraph reads, "Over all for the quarter, the company reported a profit of $550 million, or 93 cents per share, down from $802 million, or $1.31 per share, a year earlier."

But, even before this, in the previous paragraph, we learn that "Caterpillar trimmed its full-year profit outlook…."

It has gotten so that expectations are more important than explanations.

Earnings have dropped, year-over-year, and we need to know why. Explanations are needed about what happened so that we can learn what management is doing to adjust to the situation.

Management "sees no end to the four-year long slide in sales from falling prices for oil and mined commodities and lower demand from key foreign markets."

"Caterpillar said anemic economic growth along with geo-political events that undermine customer confidence such as the Brexit referendum in Britain, the hostile rhetoric from the US presidential campaigns and the attempted coup in Turkey are holding down global machinery demand."

Vice-president Mike DeWalt stated in a conference call that "It's not any one thing. All of that contributes."

Mr. DeWalt continues, "We're a little more negative on the world economy. We have sluggish economic growth throughout the world, but not enough to drive growth in our end markets."

The article continues, "Company executives said recent growth in US housing and infrastructure construction is helping to stabilize demand for earth-moving equipment in North America, but added that equipment inventories remain elevated and dealers are facing market pressure to offer discounts on machinery."

In response, "Caterpillar has been aggressively slashing its costs in the wake of lower sales…Caterpillar said it would cut an unspecified number of additional jobs later in the year on top of more than 10,000 jobs the company already plans to eliminate through 2018…The company also intends to close or consolidate up to 20 plants by the end of 2018."

So, company management believes that this is the picture the company faces going forward from where it has come over the past four years or so.

Yes, there are estimates of what these actions within this kind of environment will do, but these expectations can be anything but certain.

Actually, given the environment, the potential outcome over the next several years is highly uncertain.

And, you are going to base future stories upon whether or not Caterpillar is going to beat earning estimates by two cents…or four cents?

To me, the two big takeaways from this earnings report is that, in management's eyes, economic conditions are not all that good and are not expected to get much better, and, that there is a huge amount of uncertainty about the future.

Management is responding to these conditions by restructuring the company and doing so in a pretty dramatic way.

Two questions seem to arise out of this scenario. First, does the view of the economic conditions seem reasonable? Second, does management's response seem appropriate?

Furthermore, taking a more macro look at this situation, it is appropriate to ask how this fits into the overall picture of corporate earnings results? The economy has experienced five years of year-over-year declines in corporate earnings.

Does the Caterpillar experience fit into this general scheme of things or is it an outlier?

If Caterpillar's picture fits into the general scheme of things, it would seem that we might expect a few more years of year-over-year earnings declines…not a happy sight.

Caterpillar, with their outlook for the economic situation, certainly is not going to be putting out much money in business investment expenditures. Economic growth is too weak and uncertainty about the future is too great.

Is the Caterpillar experience, in terms of business investment, similar to that being felt in others areas of the business world? If it is, then this re-enforces the reasoning behind the weakness in business investment spending in the economy as a whole.

There is a bigger picture and more important questions to ask about the earnings performance of a company than just whether or not the earnings projections were achieved or not. I believe that the resources of a company can be put to better use than making sure that each quarter earnings projections are exceeded by two cents…or four cents.

I think that Caterpillar's earnings says a lot about the economy and is consistent with what we are hearing from other companies. In addition, I think that it is important to hear how Caterpillar's management…as well as the managements of other companies…is responding to these economic conditions. There are more important things to consider than whether or not earnings projections were exceeded. We are learning in many areas that "forward guidance" is not all that it was expected to be.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.