Caterpillar Earnings: Can The Earnings Growth Continue ?

Caterpillar’s (NYSE:CAT) stock surged 5% during pre-market trading as the company announced a tremendous market beat. The mining and construction equipment manufacturer released its first quarter results on Thursday, reporting revenue of $12.7 billion, a 4% year-on-year decline, but $320 million above market expectations. ^[1] Excluding one-time restructuring costs, earnings per share came in at $1.86, beating market expectations by a solid 37.8%.

On one hand, currency headwinds ate into Caterpillar’s top line, which also suffered due to weak mining and construction equipment sales volume, while on the other it reduced the company’s operating expenses. This was due to Caterpillar’s manufacturing and materials sourcing presence outside of the U.S., which resulted in lower costs when translated to U.S. dollar.

Because of the strong earnings growth in the first quarter, Caterpillar decided to revise its earnings per share guidance upward to $5.00, excluding one-time restructuring costs, compared to its previous guidance on $4.75. However, it has maintained its revenue guidance of $50 billion. Caterpillar also announced that it expects a $100 million increase in its restructuring expenses, totaling $250 million.

Caterpillar’s stock ended the day at $84.79, reversing the pre-market trading gain, as investors cashed out fearing weakness in the quarters to come, which may drive the stock down.

See our complete analysis of CAT here

Revenue Declines on Mining And Construction Weakness

Caterpillar’s resource and construction industries revenues declined 9% and 7%, respectively, as past trends continued to present headwinds. ^[1] Both segments suffered from unfavorable impact of the weaker euro. The construction industries segment was also plagued by a weak Japanese yen. Low prices of commodities such as copper, coal and iron ore have led to reduced investments in mines and machinery, resulting in lower sales for Caterpillar’s resource industries segment, which manufactures mining equipment. Sales of Caterpillar’s construction equipment were suppressed due to tough comparisons against last year’s sales to Brazil’s government and weakness in China’s construction activity. Lower construction activity in Asia Pacific, Europe, Africa and the Middle East discouraged dealers from stocking inventory, leading to lower sales.

In the first quarter, Caterpillar also reported significant declines in backlogs and new orders, primarily related to mining and construction equipment. The order backlog was $16.5 billion, $2.8 billion less than the first quarter 2014 and $0.8 billion less than the end of 2014. ^[1] This presents a threat to Caterpillar’s future cash flows if its backlogs continue to dry up and new orders do not flow in.

First Quarter Strength May Not Continue Through The Year

Unlike past quarters, the primary reason behind Caterpillar’s significant earnings beat was not the company’s operational productivity. Earnings were up primarily due to the gain on sales of its remaining ownership in its third-party logistics business. ^[1] Since this gain would be absent from the coming quarters, growth in first quarter earnings will not persist. Though higher price realizations also contributed to earnings growth, the decline in demand for mining and construction equipment will more than offset any benefits.

Caterpillar will likely face weak growth in the coming quarters due to the negative impact of falling oil prices on its energy and transportation segment. 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. As a result of declining oil prices, oil and gas companies have reduced capital spending in order to maintain cash flows. This led to flat revenues at Caterpillar’s energy and transportation segment in the first quarter. Since oil prices currently remain below sustainable levels of $80-90 for Caterpillar and its customers, the company expects its energy and transportation sales to decline over the coming quarters.

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

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1. Caterpillar’s 1Q 2015 Earnings Release, April 23, 2015, www.caterpillar.com [↩] [↩] [↩] [↩]