Weak Demand Clips Caterpillar’s Earnings And Outlook

Caterpillar (NYSE:CAT) posted a severe decline in its revenues and profits in the first quarter on lower dealer inventories and weak end user demand. Revenues of declined by 17% year-over-year to $13.2 billion and earnings declined by 45% year-over-year to $1.31 per share in the first quarter. ^[1] Driven by weak order rates from the global mining, construction and power sectors, Caterpillar dealers lowered their inventories significantly during the quarter. This impacted the sales volume and profits at Caterpillar.

In anticipation of sustained weak demand particularly from mining companies, Caterpillar also lowered its outlook for 2013. The company now anticipates sales of $57-$61 billion down from $60-$68 billion indicated earlier and earnings of around $7 per share down from $7-$9 per share indicated earlier, in 2013. ^[1]

At the same time, citing a strong balance sheet and an attractively priced stock, Caterpillar said it will resume its stock repurchase program. The management has the authorization from the board to repurchase shares worth $3.7 billion through December 2015, and it anticipates to repurchase shares worth $1 billion in 2013. ^[1] This is good news for investors who otherwise have had to do with a sharp decline in the company’s earnings in the first quarter and a steep reduction in its outlook for 2013.

We currently have a stock price estimate of $86 for Caterpillar, approximately 5% above its current market price.

See our complete analysis of Caterpillar here

Sales And Profits Decline On Lower Dealer Inventories And Production Rates

In the first quarter, Caterpillar dealers continued to lower their new machine inventories in anticipation of weak end user demand in the remainder of 2013 from mining, construction and power sectors. Caterpillar dealers lowered their inventories by around $700 million in the first quarter. In comparison, in the first quarter of 2012, they had increased their inventories by around $875 million in anticipation of higher demand in spring and summer. Thus, a major portion of the 18% or $2.8 billion y-o-y decline in CAT’s machine sales in the first quarter came from the decline in dealer inventories. ^[1]

This decline in CAT’s machine sales was slightly offset by a 5% or $33 million y-o-y jump in CAT Financial’s sales. Overall, the sales of the company declined by 17% y-o-y in the first quarter. ^[1]

Additionally, due to the suppressed purchase activity of its dealers, Caterpillar lowered its production rates steeply during the quarter. The company lowered its own inventory by around half a billion dollars. However, the cost impact from lower production driven by manufacturing inefficiencies added to the negative impact from lower sales volume to reduce the company’s profits steeply.

In all, the operating profit of the company declined by $1.1 billion or 48% y-o-y in the first quarter. Of this, $978 million was brought about by lower sales volume and $317 million by the cost impact from lower production rate. ^[1] The decline from these two factors was partially offset by pricing gains and rise in profits at CAT Financial.

A Challenging 2013 Ahead

Looking ahead, for the remainder of 2013, Caterpillar faces a tough business environment in each of its businesses –  mining, construction and power systems.

Mining companies have forecast steep declines in their capital investments in 2013, which will impact sales of mining machinery and equipment. Caterpillar currently estimates that sales of its traditional mining machinery – mining trucks, loaders and bulldozers could decline by as much as 50% in 2013, compared to 2012. The company also estimates that sales of its mining products acquired from Bucyrus can decline by around 15% y-o-y in 2013. ^[1]

However, we anticipate that if the global economy continues to recover, then prices of most commodities including iron ore and copper, will likely not see major declines in 2013. Caterpillar too anticipates prices of most commodities in 2013 to average slightly above their levels in 2012. This will likely mobilize mining companies to raise their capital investments towards the end of 2013 or early 2014.

Additionally, the Eurozone continues to be in recession with its economy expected to decline by 0.5% in 2013. ^[1] As a result, construction spending will likely continue to decline from the region throughout 2013. This decline from Europe will likely be partially offset by rising construction spending from China, but all in all, 2013 will be a challenging year for Caterpillar.

Understand How a Company’s Products Impact its Stock Price at Trefis

1. Caterpillar’s Form 8-K, first quarter earnings, April 22 2013, www.caterpillar.com [↩] [↩] [↩] [↩] [↩] [↩] [↩] [↩]