Caterpillar’s (NYSE:CAT) first quarter earnings were slightly below expectations and show that the company might have to battle an unfavorable macro environment to achieve its targets for the present fiscal year. While its revenues have increased by 23% to reach $12.9 billion in the first quarter, profits increased by 29%. The company has, however, seen a number of worrying trends. The sales of the company in high growth markets like China and Brazil have slowed down while there has been an increase in the company’s manufacturing, SG&A and R&D costs, which could weigh on its outlook.
Caterpillar principally competes with other industrial equipment manufacturers like CNH Global NV (NYSE:CNH), Komatsu (KMTUY.PK) and Volvo AB (VOLVY.PK). We currently have a Trefis price estimate of $108 for Caterpillar’s Stock, which is slightly below the current market price.
Mining and North American construction industry lead growth
Caterpillar’s revenue growth was mainly driven by growth in its mining business and orders from U.S. customers looking to upgrade their fleets. The acquisition of Bucyrus helped in part as not was CAT able to retain Bucyrus’s customers, but an expanded portfolio has also helped in attracting new ones. Caterpillar was also helped by the economic growth of the developing countries which pushed up mining activity in spite of a decrease in commodity prices.
In the U.S., the construction industry remained depressed but saw increased inventory build up by dealers in anticipation of economic growth. The dealer reported inventory was up by $875 million in this quarter as compared to $825 million in the first quarter of prior year. Most of the orders which came to these dealers were by customers looking to upgrade their aging fleet. Caterpillar was able to capitalize on this trend to increase sales in this region.
The continuing unfavorable macroeconomic environment of Europe and the cooling economies of Brazil and China remain a concern for the company. It has experienced a slow down in its sales in all these regions during last quarter. Although the company is positive about the environment improving in the next few quarters, we feel that there could be more pain left in the short term. Europe’s sovereign debt crisis is likely to continue in the coming quarters, and emerging economies may pass monetary tightening measures that could weigh on growth.
Profits increase but margins growth almost negligible
Caterpillar recorded a 29% growth in its profits in the last quarter on the back of increased sales volume and better price realization. Profitability, however, did not improve due to increases in manufacturing costs, SG&A costs and R&D costs. While the manufacturing costs were pushed higher by high steel prices and capacity expansion programs, the SG&A and R&D costs increase was primarily due to higher volume, increased costs to support product programs and wage and benefits inflation.
Financial Products on the right trajectory
Caterpillar Financial segment reported a 4% increase in revenues and 45% increase in profits in the last quarter. While revenue increase was due to a favorable impact from higher average earnings assets, the increase in profit was principally due to decrease in credit losses and improvement in net yield on average earnings assets. This shows that the company has been successfully removing risky assets from its balance sheet and replacing them with higher quality assets like financial receivables and operating leases at constant rates. We feel this is the right direction for the company and will yield further improvements in profitability in the coming quarters.