The Year 2016 In Review: Another Challenging Year for Caterpillar

The year 2016 was a challenging one for the American heavy equipment manufacturer Caterpillar Inc. (NYSE: CAT). The company saw nearly 15% to 25% decline across all its major segments, including energy & transportation, construction industries and resource industries. The demand remained subdued because of  economic uncertainty caused by Brexit vote in European Union, where more than 20% of its workforce are employed, and lower commodity prices, especially with the downturn in the oil industry. Caterpillar tried to offset this through its restructuring efforts, but it wasn’t enough. However, the recent OPEC deal to cut oil production should result in higher commodity prices globally and Caterpillar’s earnings could benefit in two to three quarters from now. Despite the weakness in all the industrial segments of Caterpillar, its stock price rose more than 25% in the last 6 months due to Caterpillar’s restructuring program and a boom in U.S. exports in the second half of 2016.

Caterpillar’s Stock Price Increased Despite Increase in its Industrial Sales

A decline in construction equipment sales in China was expected, as both housing and infrastructure  construction fell,  due to the slowdown of Chinese economy and decline in commodity prices. However, other unexpected global events such as Brexit vote led to significant decline in European construction industry as well. As a result, Caterpillar’s construction industry sales declined by about 19% in the first 9 months of 2016. On similar lines, Caterpillar’s resource industry and energy & transportation segment also witnessed huge declines resulting from lower crude oil prices.

Caterpillar’s stock price has increased steadily in 2016 with some fluctuations during the Brexit vote despite no share repurchase by the company in the first nine months of 2016. Caterpillar’s stock price increased due to a number of factors including Caterpillar’s improved income due to its restructuring program, increased U.S. exports in second half of 2016 and quarterly improvement in Caterpillar’s earnings.

Restructuring efforts continued in 2016 but not enough to offset declines

Caterpillar continued to work on its restructuring program in order to offset the decline from the above segments but, the gains from restructuring were very low compared to the decline. Caterpillar announced its restructuring and cost reduction plans in September 2015 with the aim of reducing operating costs by $1.5 billion annually once fully implemented. Caterpillar cut about 16,000 jobs in 2016, 6,000 more than its earlier estimates.  The company is set to save about $0.7 billion by end of 2016. Overall, Caterpillar continued to witness the challenging time in all of its segments despite its restructuring efforts.  But the tables may turn soon due to the OPEC deal to cap their oil production, which already caused 10% surge in crude oil prices.

Downturn in the oil industry continued in 2016

Crude oil prices fluctuated in 2016 but remained below $50 per barrel for most of the year and that resulted in lower commodity prices globally. Thus, mining activities declined globally, especially in China.  As a result, Caterpillar dealers failed to restock their inventories.

Caterpillar’s energy and transportation sales are also driven by crude oil prices and we expected this segment to decline. However, the extent of decline was greater than our initial estimates. However, with the signing of OPEC deal to cap oil production, we expect a recovery in both resource and energy industry in the next few quarters.

Overall, 2016 remained a difficult year for 2017, but with the OPEC deal signed, Caterpillar may see some improvement by the end of 2017.

We will follow up this analysis with the expectations for 2017, and how our valuation fits in that. Meanwhile, please let us know your views by commenting in the box below.

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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