In Caterpillar (CAT)'s 10/22/12 earnings release they reported a 49% increase in Q3 earnings per share (from $1.71 to $2.54) on a 5% increase in revenue. A closer look at the underlying details and cash flows paints a much more ambiguous picture.
First, CAT made clear that although profits and sales were up, new orders declined significantly from $28.2 billion at the end of Q2 to $23.1 billion at the end of Q3. This is an 18% decrease in one quarter. All segments were down, but "with the most significant decrease in Resource Industries," the largest driver of profit in Q3 ($1.11 Billion). In the Bucyrus division, acquired in 2011 and selling mainly mining equipment, sales were actually down Y-O-Y from the same period in 2011.
A significant change in the underlying business shows up in the cash flows:
- Y-O-Y, for the 9 months ending 9/30/2012 Operating Cash Flow declined almost 41% from $5.52 billion to $3.26 billion even as profit was up 47% from 3.419 billion to 5.022 billion.
- As CAT states, a big chunk of this is the change in Accounts Payable, a net 1.642 billion dollar negative contribution to cash flow. This presumably reflects a large over-investment in building inventory that has to be pared back through lower raw material and parts purchases.
- Increasing Inventories also continue to be a net drag on cash. They subtracted an additional sequential $400 million in cash in the first 9 months of 2012 compared with 2011. (-3.118 billion in 2012 v. -2.716 billion in 2011)
Overall, the sum of Net Cash provided from Operating and Investment activities for the first 9 months of 2011 vs. 2012 (I netted of gains and losses from 1) Investments and Acquisitions and 2) Proceeds of sales of businesses and investment which can vary considerably from Q-to-Q and Y-to-Y) comes to:
- 2011: $3.457 Billion
- 2012: $-1.557 Billion
This is a massive negative $5.014 billion swing in cash flow and most likely reflects over-investment in inventory and capacity that will have to be pared back as the world economy slows and CAT adjusts its business to align better with true demand and low-cost (quasi-state) competitors like Sany and Zoomlion in China.
Finally, there was a 25% increase in additions to finance receivables for the 9 months ending Sept. 2012 while collection of finance receivables was flat. This is a $1.744 billion increase in finance receivables with only a negligible change in collections. The worry here is that CAT is increasingly financing customers' purchases to maintain sales momentum. We have recently heard that Sany and Zoomlion have been financing their customers' purchases in China at a rapid clip, a worrying trend for the industry if these receivables start going bad.
In summary, the new order book is shrinking rapidly and cash flows from the key parts of the business - Operating and Investing - have turned negative. If the world economy continues to slow, as CAT predicts (2.5 % for 2013, the weakest since 2009) CAT shares may have additional downside.
Disclosure: I am short CAT.