Caterpillar Pre Earnings: Another Challenging Quarter For Caterpillar?

Caterpillar (NYSE:CAT) will declare its Q2’16 earning results on October 25th. We expect mid to low single digit growth in earnings due to about 21% increase in crude oil prices in Q3’16 and company’s restructuring efforts which were announced in September 2015. We expect the construction equipment sales to remain weak due to lower used equipment prices worldwide and uncertainty in global economy from Brexit vote and sluggish growth in China. Although, Caterpillar’s restructuring efforts have started to pay off, they are likely to be offset by slower GDP growth of developed economies and less construction starts in the U.K. where Caterpillar has significant sales.

Construction equipment sales to remain weak as North America market declines

Exports of U.S. made construction equipment declined by 24% year on year in the first half of 2016 primarily due to stronger U.S. dollar. Slowdown of China and lower commodity prices have also contributed to the decline in equipment sales. U.S. Agricultural equipment exports to Canada and and Central America declined by 23% and 7% respectively in the first half of 2016.This trend is likely to spill over to Q3 results.

Additionally, United Kingdom’s vote in favor of Brexit has added some amount of uncertainty in the markets which may have slightly negative impact on Caterpillar’s 2016 earnings, as a significant chunk of its revenues comes from United Kingdom. The company employs about 10% of its total workforce in the U.K. itself along with 1 R&D facility. China has not recovered completely from its economic slowdown which may impact Caterpillar’s sales negatively. This is evident from the fact that world’s Economic Impact Index declined from 46.7 points in Q3’15 to 44.0 in Q1’16 and has continued its decline. We believe that Caterpillar’s revenues are likely to be negatively impacted from these events as about 45% of its total sales comes from EMEA and Asia pacific region.

Resource, Energy and Transportation industry may see marginal increase in revenues

Crude oil prices surged by 21.5% in Q3’2016 as Organization of Petroleum Exporting Countries (OPEC) finally concluded that they will cap their combined oil production between 32.5 and 33 million barrels per day. Although this triggered an oil price surge, Iran and others may not commit to it as the final agreement has not been signed yet. Iran may resist again as it emerged from years of international sanctions in January 2016.

Improved oil prices are likely to strengthen oil and gas industry resulting in increased revenues for Caterpillar’s Resource, Energy and transportation division. However, the increase will be marginal in this quarter as the uncertainty over oil prices continues. Thus, we forecast 13.8% decline in overall revenues of Caterpillar for full year 2016 due to company’s weak performance in first half of 2016, weak construction and uncertainty over crude oil prices.

Restructuring and cost reduction

Caterpillar’s EBITDA has declined by 27.5% since 2013 and stood at $6.7 billion in 2015. If the company executes its cost reduction plan effectively, we estimate $0.7 billion reduction in costs by the end of 2016. Under its restructuring plan, Caterpillar has already cut about 16000 jobs, and expects facility consolidations and closures to impact about 20 of its facilities and 10% of its manufacturing square footage since September 2015.

Despite these efforts, Caterpillar was not able to offset its revenue decline in the first half of 2016, but we may see improved margins in Q3’16. We expect company’s overall EBITDA margin to decline from 14.3% in 2015 to 13.6% by 2017, but recover thereafter to reach 14.0% by 2020 due to revenue revival and cost rationalization.

Notes:

1) The purpose of these analyses is to help readers focus on a few important things. We hope such lean communication sparks thinking, and encourages readers to comment and ask questions on the comment section, or email content@trefis.com

2) Figures mentioned are approximate values to help our readers remember the key concepts more intuitively. For precise figures, please refer to our complete analysis of Caterpillar

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