Caterpillar - Slower Economic Growth Will Impact Short-Term Profitability

| About: Caterpillar Inc. (CAT)

Shares of Caterpillar (CAT) ended Monday's trading session with gains of 1.5%. Shares initially fell to $82.50 after the open and rallied back to $86, to settle around $85 per share. The manufacturer of construction and mining equipment reported its third quarter results before the market open.

Third Quarter Results

Caterpillar reported third quarter revenues of $16.45 billion, up 5% on the year. Revenues fell short of analysts expectations of $16.79 billion.

The company reported earnings of $1.7 billion for the third quarter. Earnings include a pre-tax gain of $273 million from the sale of a majority interest in the company's third party logistics business. Reported earnings per share, including the one-time gain, rose 49% to $2.54 per share. Both earnings, and revenues were at record levels. Analysts expected earnings to come in at $2.23 per share.

CEO and Chairman Doug Oberhelman commented on the results,"Last quarter and then again a month ago at MINExpo, we discussed economic and geopolitical headwinds facing the world, and we are certainly continuing to see the impact of those uncertainties in our business. Even so, we had a record third quarter, and our entire organization is focused on finishing 2012 as the best year for sales and profit in our history. Despite the turbulence in the global economy, we continue to track toward our goals on cost control, margin improvement, product quality, safety and better product availability for our customers."

Segmental Information

Construction Industries

Revenues from the construction division came in unchanged at $4.90 billion. Revenues in North America rose 23% to $1.91 billion, on the back of the housing recovery. Growth in the US was partially offset by a 23% decline in Latin American revenues to $629 million. Unfavorable exchange rates played a large result in this. Revenues in Asia fell 18% to $1.18 billion. Operating profits fell by 7% to $459 million.

Resource Industries

Revenues for the resource division rose 13% to $5.21 billion. The Asian division reported a solid 27% growth in revenues to $1.86 billion. Latin American revenues rose 18% to $1.00 billion, and North American revenues were up 8% to $1.42 billion. Operating profits rose 49% to $1.11 billion. Excluding the $150 million of acquisition costs of Bucyrus in 2011, profits rose 29%. The acquisition of Bucyrus added $1.09 billion in quarterly revenues.

Power Systems

Power segment revenues rose 5% to $5.32 billion. Growth was entirely driven by a 24% increase in Asian revenues to $1.04 billion. Growth in all other geographic areas came in around flat. The acquisition of MWM added $143 million in quarterly sales for the division. Operating profits rose 19% to $943 million.


For the full year of 2012, Caterpillar now anticipates revenues to come in around $66 billion. Full year earnings per share are anticipated at $9.00-$9.25 per share.

Earlier, Caterpillar guided for full year revenues of $68-$70 billion. Profits were originally estimated around $9.60 per share, at the midpoint of its previously guided range.

The lowered guidance implies fourth quarter revenues of $16.2 billion, down slightly from third quarter revenues.

CEO Oberhelman commented on the outlook, "The decline in the sales and revenues outlook reflects global economic conditions that are weaker than we had previously expected. In addition, Cat dealers have lowered order rates well below end-user demand to reduce their inventories. Production across much of the company has been lowered, resulting in temporary shutdowns and layoffs."

Based on Caterpillar's cautious economic outlook for 2013, the company anticipates Resource Industries' sales to be down as mining companies are reducing investments in projects and equipment. Construction sales are expected to improve on the back of growth in the US and China, partially offset by weakness in Europe. Power sales are estimated to be relatively flat.

Total sales in 2013 are expected to be flat compared to 2012, plus or minus 5%. Analysts expected that Caterpillar will grow revenues by 5.1% on average in 2013.


Caterpillar ended its third quarter with $5.7 billion in cash and short term investments. The company operates with $39.7 billion in short and long term debt, for a net debt position of $34 billion.

For the first nine months of 2012, Caterpillar generated revenues of $49.8 billion. The company reported net profits of $5.0 billion, or $7.44 per diluted share.

The market currently values Caterpillar at $55.6 billion. This values the firm at 0.8 times annual revenues and 9-10 annual earnings.

Caterpillar currently pays a quarterly dividend of $0.52 per share, for an annual dividend yield of 2.4%.

Investment Thesis

Year to date, shares of Caterpillar have fallen some 6%. Shares rallied from $90 in January to highs of $115 in February. Concerns about global economic growth and cautious comments about prospects in China send shares to $80 in July. Shares recovered to $85 at the moment.

Over the past five years, shares have risen some 15%. Shares fell to lows of $25 in 2009 and rose back to $115 in 2011 and 2012, before seeing a modest correction. Between 2008 and 2012, Caterpillar grew its annual revenues from $51.3 billion to an expected $66 billion in 2012. Net income rose from $3.6 billion to an expected $6.4 billion this year.

Investors are a little worried about the developments at Caterpillar. Despite a couple of good years, the net debt position of the firm has risen to some $34 billion at the moment, roughly 5 times annual earnings. Part of this reason is that CEO Oberhelman, installed in the summer of 2010, spend over $10 billion in acquisitions during the good times.

As such, the leverage position is relatively high in a quarter in which the backlog fell by $5.1 billion to $23.1 billion, or just 4 months of revenues. The company already cut back on production to work through excess inventory. A couple of weeks ago, Oberhelman cut the firms 2015's earnings per share target from $15-$20 per year, to $12-$18 per year.

While the valuation of Caterpillar looks appealing at 9 times annual earnings, I remain on the sidelines. I am worried about the relative sizable debt position and the possibility of short term pressure on profits, in case the world economy deteriorates even further. The long term prospects still look favorable.

Disclosure: I 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.