Caterpilllar’s Earnings Decline On Weak Segments, Currency Headwinds

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Caterpillar’s (NYSE:CAT) stock declined 3.6% on Thursday, as the mining and construction equipment manufacturer released its second quarter results, reporting declines at the top and bottom lines. [1] Caterpillar has been suffering from weakness in mining and construction equipment markets and crude oil price declines, which have impacted all three of its segments – Resource Industries, Construction Industries and Energy and Transportation. To add to this, foreign currency headwinds are tempering its revenues and outlook. We anticipate these trends to continue to impact the company throughout the year.

Caterpillar reported a 13.4% decline in revenue, to reach $12.3 billion, missing market expectations by $300 million. [1] Excluding one-time restructuring costs, earnings per share came in at $1.27, a decline of 24.8%, but in line with market estimates. To placate investors, Caterpillar has announced that it will be repurchasing $1.5 billion of common stock in the third quarter.

See our complete analysis of CAT here

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Currency Headwinds Drive Down Revenues And Outlook

Around $492 million of the decline in Caterpillar’s revenue came from the impact of a strong U.S. dollar. The weaker Euro and yen were primarily responsible for the negative impact of currency translation.

On one hand, currency headwinds ate into Caterpillar’s top line, while on the other it reduced the company’s operating expenses, but only by $80 million. 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. dollars.

In the first quarter, Caterpillar had maintained its revenue guidance of $50 billion. However, due to the impact of a strong U.S. dollar, the company has now revised its revenue guidance downwards to $49 billion. Despite expectations of a heavier decline in revenue, Caterpillar’s earnings per share outlook remains unchanged at $5.00, excluding one-time restructuring costs, which seems encouraging.

Weak Mining Capital Expenditures Temper Resource Industries Revenues

As expected, Caterpillar’s Resource Industries revenues declined 11.1% in the second quarter as a result of a decline in capital investments by mining companies. Low prices of commodities such as copper, coal and iron ore, are forcing them to focus on improving productivity at existing mines and control capital expenditures.

Sales of Caterpillar’s mining equipment will likely remain weak through the year. Sales of aftermarket parts, which are generally considered to be leading indicators of health of mining equipment sales, were weak during the second quarter. New orders for the segment were weak as well. Also, Caterpillar’s backlogs for its mining and construction equipment declined $1.7 billion from the previous quarter, to $14.8 billion.

In addition, what we had earlier believed to be a possible bottoming out of sales declines, as indicated by the moderation in declines of Resource Industries retail sales, is not likely so. According to Caterpillar’s retail statistics for the 3-month rolling period ended May, retail sales for the segment were down 8%, which is moderate when compared to the 46% decline witnessed a year ago. [2] [3] However, for the 3-month rolling period ended June, retail sales for the Resource Industries segment declined 13%, breaking the trend of moderation. Therefore, the segment’s retail sales may continue to face heavy declines.

Energy And Transportation Down On Crude, Locomotives Headwinds

Sales to the oil and gas industry account for around a third of the company’s energy and transportation 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 a 12.2% decline in Caterpillar’s Energy and Transportation revenues in the second quarter. Since oil prices currently remain below sustainable levels of $80-90 for Caterpillar and its customers, we expect to see its energy and transportation sales to decline over the coming quarters.

Apart from crude oil headwinds, the segment will likely suffer due to a slowdown in sales of locomotives. U.S. railroads have been looking for new locomotives or retrofit kits for existing locomotives that would help them remain compliant with the latest emissions standards, which came into effect from January 2015. This would have been a great growth opportunity for Caterpillar’s Energy and Transportation segment, which also manufactures locomotives, if it would have been able to offer the railroad industry with the required locomotives.

Caterpillar had announced that it will have emissions-compliant locomotives ready for production only later in 2016. [4] By the time Caterpillar will be able to deliver production ready units, General Electric (NYSE:GE) will already have captured a large chunk of the market. GE has already begun testing its locomotives for compliance with the latest emission standards and should be able to provide emissions-compliant locomotives this year. This loss of market share could be a significant blow for Caterpillar, 70% of whose locomotive revenues are generated through sales to the U.S. railroad industry.

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Notes:
  1. 2Q15 Caterpillar Inc. Results, Jul 23, 2015, Caterpillar’s Quarterly Financial Results [] []
  2. 2015 YTD May Retail Statistics, Caterpillar’s Website []
  3. 2014 Retail Statistics, Caterpillar’s Website []
  4. Caterpillar (CAT) Douglas R. Oberhelman on Q2 2015 Results – Earnings Call Transcript, July 23, 2015, Seeking Alpha []