Caterpillar Earnings Preview: Revenue And Earnings Will Likely Decline

Caterpillar (NYSE:CAT) will be releasing its second quarter results on July 23. ^[1] Similar to previous quarters, we expect to see a decline in earnings and sales across all three segments – Resource, Construction and Energy and Transportation – as ongoing softness in mined commodities and oil prices continues to take its toll on Caterpillar. This is also corroborated by the company’s monthly retail sales reports. ^[2].

Earnings were up in the previous quarter primarily due to the gain on the sale of its remaining ownership in its third-party logistics business. ^[3] Since this gain will not recur in the second quarter, the growth achieved in first quarter earnings will likely not persist. Though higher price realizations may contribute to earnings growth, the decline in demand for mining and construction equipment will more than offset any benefits. The company’s planned increase in research and development expenses will also temper its bottom line.

In the previous quarter, Caterpillar reported revenues of $12.7 billion, a 4% year-on-year decline. ^[3] Excluding one-time restructuring costs, earnings per share came in at $1.86, beating market expectations by a solid 37.8%. 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 of $4.75. However, it maintained its revenue guidance of $50 billion. Caterpillar also announced that it expects a $100 million increase in its restructuring expenses, totaling $250 million.

See our complete analysis of CAT here

Oil Price Weakness To Present Headwinds

Sales to the oil and gas industry account for around a third of Caterpillar’s Energy and Transportation revenue and also a considerable portion of its Construction Industries revenue. Caterpillar’s Energy and Transportation segment provides the oil and gas industry with reciprocating engines, turbines, integrated systems and solutions, and related parts. Construction equipment is required to build wells and other infrastructure around rigs for oil and gas drilling.

As a result of declining oil prices, oil and gas companies have reduced capital spending in order to maintain cash flows, leading to a decline in demand for engines and turbines. 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, Energy and Transportation sales will likely decline over the coming quarters. This is corroborated by retail statistics for the segment, which reported a 6% decline in retail sales for the 3-month rolling period ended May. ^[2] It is pertinent to note that the decline in retail sales has become steeper through the year, which indicates that the weakness in retail sales is likely to persist.

The decline in oil prices has led to a 60% drop in rig counts, since a peak of 1,609 in October. ^[4] As rig counts have fallen, the demand for Caterpillar’s construction equipment has also weakened. This is evident from the 14% decline in Caterpillar’s Construction Industries retail sales for the 3-month rolling period ended May. ^[2] The segment is also suffering from the week construction activity in Asia Pacific, Europe, Africa and the Middle East, which has discouraged dealers from stocking inventory. Since oil prices are not expected to rebound any time soon, we expect to see construction equipment demand to remain suppressed through the year.

Resource Industries Continues To Fall

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. In 2014, the segment’s revenue declined 33% year-on-year. ^[5]

Towards the end of last year, an upswing in sales of aftermarket mining equipment parts led the market to believe that Caterpillar’s Resource Industries segment could soon turn around. In preparation for a possible turnaround, Caterpillar also began building strategic inventory. ^[6] However, on its first quarter earnings call, the company reported a decline in aftermarket equipment for the Resource Industries segment, shattering expectations of a turnaround. The current price levels of mined commodities do not support any recovery in Caterpillar’s Resource Industries segment either. Accordingly, we expect that it will take some more time before Caterpillar begins to report improvements in sales of its mining equipment.

Despite Resource Industries retail sales continually declining for the past two years, there is one silver lining. According to Caterpillar’s retail statistics for the 3-month rolling period ended May, retail sales for the segment were down 8%, significantly moderate when compared to the 46% decline witnessed a year ago. ^[7] It seems that the sales decline will likely bottom out soon.

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1. Caterpillar Inc. To Announce Second-Quarter 2015 Financial Results On July 23, July 9, 2015, Caterpillar’s Press Release [↩]
2. 2015 YTD Retail Statistics, Caterpillar’s Website [↩] [↩] [↩]
3. Caterpillar’s 1Q 2015 Earnings Release, April 23, 2015, www.caterpillar.com [↩] [↩]
4. U.S. Rig Count, Baker Hughes [↩]
5. Caterpillar’s 2014 10K SEC Filing, February 18, 2014, Caterpillar’s Website [↩]
6. Caterpillar’s (CAT) Management Presents at Credit Suisse 2014 Global Industrial Conference (Transcript), December 2, 2014, www.seekingalpha.com [↩]
7. 2014 Retail Statistics, Caterpillar’s Website [↩]