This Monday, Caterpillar Inc. (CAT), a barometer of global mining and construction activity, reported its third quarter earnings. The company topped earnings estimates, but missed the Street's revenue expectations. According to an article on The Wall Street Journal, America's largest companies are on track to report lower quarterly sales for the first time in three years, which gives the market an indication of just how unhealthy the economy is. International Business Machines Corporation's (IBM) sales slipped 5.4% this quarter on a YoY basis, while 3M Company (MMM), a giant conglomerate, also reported this Tuesday that its revenues had declined on a YoY basis.
Given that all three of them - IBM, MMM and CAT - belong to the Dow Jones Industrial Average, the market was nervous about CAT's performance in the last quarter. Fortunately for investors, CAT reported the best ever sales and earnings figure for the third quarter, in its history. However, as mentioned, revenues fell short of the market's estimate. The EPS at $2.54 was more than the estimated $2.23, and 48% higher than the EPS for the last year. Even after adjusting for the sale of a majority interest in CAT's logistics business, the EPS comes out at $2.33, which is still a beat. The reported revenue of $16.54 billion was $340 million short of the estimated $16.8 billion. However, it was still 5% higher YoY.
The earnings beat came from more-than-expected operating profit of 14.1%, though that was below the last quarter's operating profit of 15%. CAT gets most of its revenues from three main segments:
- Construction: deals in machinery used for construction purposes and infrastructural development e.g. backhoe loaders.
- Resource industries: deals with machinery for mining and quarry applications.
- Power Systems: products include reciprocating engines, diesel -electric locomotives etc.
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In the third quarter, the power system segment performed well. The margin was 17.7% for this segment, up from 15.6% in the last year. The profits for the segment improved because of the MWM acquisition.
Margins for the construction segment fell from 10.1% to 9.4% YoY. Margins for the resource industries segment improved on a YoY basis from 16.2% to 21.3%, but fell from the last quarter's margin of 26.5%. The following shows the sales performance of the different segments:
The power segment's sales got the boost from the MWM acquisition. In the construction segment, improvement in the North American market was offset by a decline in the Asian markets. However, the situation in the resource industries' segment is rather alarming. Orders are declining. CAT's dealers have cut down order rates below end-user demand in order to reduce their high levels of inventories. In anticipation of slow demand, production at CAT's facilities has been reduced through temporary shutdowns.
The resource segment performance is heavily dependent on the global mining CAPEX. CAT was already cautious at the MINExpo held recently, where it reduced its EPS outlook for 2015. Also, a JP Morgan analyst said that mining CAPEX is expected to come down by 14% through 2014.
2012 Guidance Lowered; 2013 Revenues Guided Flat
CAT lowered its 2012 EPS guidance to the range of $9.00-$9.25, down from $9.60 previously, and below the Street's estimate of $9.41. This implies a Q4 EPS of approximately ~$1.70, which is below the Street's estimate of $2.31. Revenues are expected at $66 billion, down from the previous guidance of $68-$70 billion. The reduced guidance was anticipated by the market after CAT declared its mining business to be on the decline for the near future.
CAT also gave its 2013 preliminary revenue outlook and guided in the range of up 5% to down 5% from 2012 year-end revenue. This is below the Street's estimate of 5% improvement y/y, but in line with what CAT had communicated at the MINExpo. CAT expects the first half of 2013 to be slightly weaker than the second half. However, many people in the market now believe that the company is keeping very low targets for the year so that they can be easily beaten.
The following shows revenue bifurcation:
The company gets only 3% of its revenues from China, and is looking at enhancing its presence in the country. Even though, the Chinese GDP growth rate of 7.4% was the worst in the last three years, CEO Doug Oberhelman said that a potential positive attitude change is being seen in Chinese customers. According to the CEO, the Chinese economy may be bottoming, given that positive news has started to emerge from the region.
However, the CEO remains wary of future US-China relations. The US Presidential elections in November will remain an important catalyst for the stock, given that GOP candidate Mitt Romney has declared that he will designate China a currency manipulator on his first day in office.
Another important point made in the earnings call was that Oberhelman believes that the US housing sector has bottomed. The company is expecting the construction segment sales to improve with the help of a rebound in the housing sector. However, the CEO is not satisfied with the current growth rate in the sector. He held: "We need that housing number to double to start moving the economy."
The stock is trading at a forward multiple of 8x, which is cheap, given that the average multiple of the industry is 11x. The stock also offers a healthy dividend yield of 2.5%. The current fiscal cliff has made the economic environment uncertain. People are uncertain about what the tax rates will be in the next six months or so, and where the economy is moving.
CAT's CEO believes the clouds will clear in 60-90 days, after which the outlook can be predicted with more confidence. For the short term, I recommend investors stay away from the stock, given the economic uncertainty. However, for the long run, I am bullish on CAT, given that the mining industry is here to stay for always. The November elections will serve as an important catalyst.