A Deeper Look At Catapillar Earnings: Lowest Sales Since 2012 Peak On A Hostile Macro Environment And Weak Targeted Markets

Caterpillar (NYSE: CAT) reported lower than expected third quarter earnings on October 22, 2015. The company posted lower sales volumes across its  segments and currency issues further added to the woes. ^[1] The most significant volume decrease was observed in Latin America ( down 31%) and Asia -Pacific (down 25%), primarily due to slower economic growth that in turn nduced lower demand for construction equipment and spending. Besides construction, Caterpillar has seen a downturn in its resource industries segment sales, due to the continued slump in mining activity since 2012, which is the result of weakened commodity prices. The unfavorable impact of currency has been another contributor to weak sales with continued strengthening of the U.S. dollar against other currencies and hence lower price realization. Caterpillar has revised its revenue outlook for 2015 from $49 billion to $48 billion and expects a 5% decline in 2016 which would be a fourth straight down year, a first in the company’s 90-year history.

As a result of continued weak performance and lower than expected sales, we observe the company’s stock price has plunged around 25% this year, compared to the broader S&P 500 index which rose 6.5% during the same period. ^[2]

See our complete analysis of CAT here

Continued Weakness In Construction Segment Sales In Slowing Brazil And China, Partially Offset By Recovery in North America

Even as the economic growth slows, we have observed some relief in construction activity in North America. Construction remains a bright spot with housing and non-housing construction activity picking up in the U.S. in response to increasing demand. This was partially offset by decline in oil-related construction due to slumping oil prices.

In the third quarter, Latin America and Asia/Pacific (primarily Brazil and China) sales declined by 43% and 27%, respectively, amid slowing economic growth and  weaker construction activity. Both residential and non-residential construction activity remained weak, contributing 61% of the decline in sales volume for both new equipment and aftermarket parts. Price realization (contributing 6% of the decline in sales) was also a challenge considering the depreciation in the Brazilian Real and Chinese Yuan against the strong U.S. Dollar, translating to lower sales in Dollar terms. The short term outlook for both economic growth and exchange rate for the two regions remains negative, implying a further decline in construction segment sales in the coming fiscal.

Negative Outlook For Battered Oil Prices And Weak Mining Activity To Drive Lower Sales

Falling oil prices have posed a major challenge to Caterpillar’s energy and transportation segment sales, which declined 25% in the third quarter.  Lower volumes contributed 87% by decline in sales, followed by the impact of unfavorable foreign exchanges rates. This is primarily a function of falling oil prices to a six year low in August and continued weakness due to oversupply in the global market. ^[3] Rig count, which is an indicator of future production, has fallen by around 62% since last October, implying a negative outlook for oil prices in the short term, despite slight correction in demand globally. Also, Moody’s recently lowered its 2016 price assumption from $57 per barrel to $53, reflecting further pessimism. ^[4]

Caterpillar’s resources industries segment does not inspire much optimism either, with the total segment sales declining by 17% for the quarter due to massive decline in sales volume (contributing 83% of the sales decline). Globally, there has been a decline in mining activity since 2012 primarily attributed to weakening commodity prices. Sales for new equipment continued to weaken, as mining customers remain focused on improving productivity of existing mines in a hostile mining environment. The Asia-Pacific region was the worst hit with a 29% decline in sales on account of low sales volume and unfavorable impact of currencies We expect further downside to the segment sales as a result of negative outlook for mining activity in the short term due to weakening commodity prices.

Implementing Cost Reduction And Restructuring Initiatives Efficiently

In September, the company announced significant cost reduction and restructuring efforts. They are now increasingly spending on restructuring activities such as significantly lowering Capex , consolidating or closing down 20 additional production centers by 2018, and laying off around 10,000 members of the workforce by 2018. ^[5] Through these efforts, the company hopes to save $1.5 billion in operating costs annually, expanding the operating income margin by approximately 1.5% – 2.0%. We will watch out for successful implementation of these efforts and their impact on margins and earnings.

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1. Caterpillar Announces Third Quarter Results, Caterpillar, October 22, 2015 [↩]
2. Caterpillar Stock Price Movement, NYSE, October 22, 2015 [↩]
3. US Oil Prices, The Wall Street Journal, October 9, 2015 [↩]
4. Moody’s Lowers Oil Price Assumptions, Moody’s, October 19, 2015 [↩]
5. Caterpillar Announces Restructuring And Cost Reduction Plans, Caterpillar, September 24, 2015 [↩]