Caterpillar Earnings: Outlook Disappoints More Than Results

Caterpillar (NYSE:CAT) reported its fourth quarter results on Tuesday, January 27. The company’s revenue declined 1% year-on-year to $14.2 billion due to currency headwinds, primarily the Euro and Japanese yen. ^[1] Sales volume was relatively stagnant, as declines in Caterpillar’s Resource and Construction Industries segments were offset by the Energy and Transportation segment.

After growing in the first three quarters of 2014, Caterpillar’s profits took a dive in the fourth quarter. Profits declined 25%, largely as a result of costs associated with the introduction of new products and higher incentive expenses associated with sales. Caterpillar’s earnings per share declined 20%, to $1.23. Excluding restructuring costs, earnings per share came in at around $1.35, around $0.20 lower than analyst expectations.

Though its fourth quarter results were the weakest of the year, it was Caterpillar’s poor revenue and earnings outlook for 2015 that hurt the stock, which declined by 7% on the day.

See our complete analysis of CAT here

Mining And Construction Weakness Pressure Top Line

Caterpillar’s Resource and Construction Industries revenues declined 10% and 9%, respectively, as past trends continued to present headwinds. ^[1] Low prices of commodities such as copper, coal and iron ore, have led to reduced investments in mines and machinery, resulting in lower sales of new mining equipment. However, since mining companies have been working their existing machines for longer durations in order to keep operating costs low, the wear and tear of such machines has led to an increase in sales of aftermarket parts.

Sales of Caterpillar’s construction equipment were suppressed primarily due to tough comparisons against last year’s sales to the Brazil government. Lower construction activity in Asia Pacific, Europe, Africa and Middle East discouraged dealers from stocking inventory, leading to lower sales. The weak Japanese yen and Euro also presented headwinds.

Outlook Falls Along With Oil Prices

After having managed flattish revenues and weak earnings growth for the full year 2014, Caterpillar expects its 2015 revenue to decline by around 9% year-on-year, to $50 billion, and earnings per share to fall by 25%, to $4.75 (excluding restructuring costs). ^[1] The primary reason behind this decline is the dramatic drop in crude oil prices. Crude oil fell from a peak of $115 per barrel in June 2014 to just below $50 per barrel in January as a result of rising global production.

Apart from growth in production in the U.S., global crude oil supply is also receiving a boost due to the unwillingness of OPEC to lower their output, fearing that it will negatively impact their market share. On the demand side, China, the largest oil importer in the world, is likely to import less in the near term given that its GDP growth is expected to decline from 7.4% in 2014 to 7.0% in 2015. ^[2]

With a significant demand-supply mismatch, it is unlikely that crude oil prices will rise anytime soon. Oil producers are likely to reduce their capital spending on account of the unsustainable price levels. This certainly sparks a concern for Caterpillar, whose sales to the oil and gas industry account for around a third of its Energy and Transportation revenue and also a considerable portion of its Construction Industries revenue.

Apart from the headwinds due to crude oil, Caterpillar’s results will continue to be plagued by the weak mining environment. Construction equipment sales could continue to suffer from slow growth in China and tough comparisons with Latin American markets. The company’s planned increase in research and development expenses will also temper its bottom line.

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1. Caterpillar’s 4Q 2014 Earnings Release, January 27, 2015, www.caterpillar.com [↩] [↩] [↩]
2. China plans to set 2015 growth target at ‘around 7 percent’ – sources, January 28, 2015, www.reuters.com [↩]