Caterpillar’s situation worsens in Q3’16 despite restructuring affects

Caterpillar (NYSE: CAT) announced its Q3’16 earnings on October 25th and the results came in significantly below consensus estimates. Caterpillar witnessed declines in all of its industrial segments due to weakness in the Oil & Gas, Construction and Resource industries. Commodity prices stabilized over the last quarter but are still relatively low. Economic uncertainty in Europe caused by Brexit vote has also affected Caterpillar’s construction equipment sales which was evident from about 8% decline in construction equipment sales in Q2’16. Although, crude oil prices surged in Q3’16, it will be another couple of quarters before it is reflected in the earnings, given the latency of pricing in supply and demand. Caterpillar’s restructuring effects have started to pay off but not sufficient enough to offset the impact of revenue decline.

Overall, we believe that Caterpillar will continue to face tough conditions at least for the next few quarters due to general weakness in its markets. However, we expect its sales to bounce back post 2017 due to expected recovery in oil & gas industry and stability in European and Chinese economy which are the most significant markets for Caterpillar in terms of revenues.

Caterpillar’s business will remain weak next year

Caterpillar’s revenues declined by about 16% in Q3’16. This decline was spread across all of its industrial segments, i.e. Energy & Transportation, Resource and Construction equipment. We believe that this trend likely to continue in 2017 expected well.

The decline in energy and transportation sales of Caterpillar started in the 2nd half of 2015 due to fall in commodity prices. This was driven by the economic slowdown in China and overproduction of crude oil from OPEC countries. As there are no clear signs of recovery in oil, gas and rail industry, we believe that the situation will remain grim for this segment in the next three to four quarters. However, it is expected that OPEC countries will cap their production in next few months, which may bring some relief.

Commodity prices have stabilized in the last few months but are still low compared to their 2014 levels. Resource industry sales are highly correlated with commodity prices and thus, are expected to decline in the near term. Particularly for Q3’16, resource industry sales were also affected by decline in Caterpillar’s construction sales decline, especially in North America as some of the large wheel loaders are used in construction.

Construction industry sales have fluctuated in the last few quarters for Caterpillar, but are also expected to remain flat to down in the coming quarters due to weakness in North American construction industry which accounts for about 46% of Caterpillar’s construction sales. Although, there are some economic uncertainties globally which are impacting construction industry in Europe and the U.S., Caterpillar is gaining ground in China and other developing countries such as Brazil. Overall, we believe that it will take another couple of quarters for Caterpillar’s construction sales to stabilize.

Restructuring paying off but the impact is insignificant

Caterpillar’s restructuring plan was announced in September 2015 aimed at reducing operating costs by $1.5 billion annually once fully implemented. 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. Restructuring effects have started to pay starting Q2’16 but the impact, however, is insignificant as the revenue decline has been sharp.

We expect company’s overall EBITDA margin to decline from 14.3% in 2015 to 13.6% by 2017, but recover thereafter and reach 14.0% by 2020 due to combination of 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

View Interactive Institutional Research (Powered by Trefis):

Global Large Cap | U.S. Mid & Small Cap | European Large & Mid Cap

More Trefis Research