Key Takeaways From Caterpillar’s Earnings

Caterpillar (NYSE: CAT) released its Q1’17 earnings on April 25, beating consensus estimates for revenue by nearly $600 million. The results were driven by strength in the Asia Pacific construction industry, increased resource industry demand from Latin America and strength in aftermarket sales of oil & transportation products. Revenue from financial products also increased 2% this quarter due to higher average financing rates. Restructuring costs have been pressuring Caterpillar’s profits for the last several quarters, and that continued in Q1’17. Caterpillar’s restructuring costs are likely to go up further in the coming quarters. We see some early signs of recovery in the resource and energy industries, but the volatility in commodity and oil prices continue to pose risks.

Jump in After Market Sales, Construction Rebound in China

Caterpillar’s revenues in Q1’17 increased nearly 4% due to higher sales in the resource industry in Asia Pacific and increased Energy and Transportation demand in Latin America. Mining commodity prices have been increasing for the past couple of quarters, which drove the demand for both new and used equipment in the resource industry. These are early signs of recovery in the industry, but dealers will likely wait for another few months before stocking up inventories. This was also the reason that Caterpillar’s resource industry aftermarket sales saw increased demand in the first quarter of 2017 leading to a nearly 15% increase in the segment’s revenues. Overall, we expect these segments to rebound slowly as oil and commodity prices inch up.

Caterpillar’s construction industry sales declined nearly 25% in 2016 primarily due to volatility in commodity prices, lower prices for used equipment and declining construction industry sales in North America and Europe due to regional geopolitical uncertainty. However, this was offset by a 23% increase in Caterpillar’s construction equipment sales in Asia Pacific in Q1’17. Strength in Asia primarily came from China, where increased government support for construction and strong residential investment led to increased demand. However, this was partially offset by the change in dealer inventories and availability of used equipment in North America.

What Are The Risks For Caterpillar Going Forward?

Caterpillar’s Q1’17 profit per share excluding restructuring costs exceeded consensus estimates by more than 100%. However, if the restructuring costs are included, the actual profit per share declined nearly 30%. Caterpillar’s restructuring program started in late 2015 when Caterpillar suffered huge losses due to the downturn in the oil and resource industry. Caterpillar’s restructuring costs will continue to grow in 2017 due to its announced restructuring of its manufacturing facilities in Gosselies, Belgium, and Aurora, Illinois. Although the restructuring efforts have increased cash flows and strengthened the balance sheet, they will continue to put pressure on the company’s short-term profits.

Although we see some early signs of recovery in the resource and energy industries, it is still too early to tell whether it is sustainable. Oil prices went up after the OPEC deal, but crude oil has not moved beyond $55 despite the capped oil supply by OPEC nations. Commodity prices, on the other hand, are increasing but are still very low compared to 2014. In the construction industry, the U.S. government’s proposed $1 trillion infrastructure spending is still not in sight for another few quarters. The political uncertainty in Europe and the United Kingdom has also impacted the progress of infrastructure projects.So while the markets have improved from last year, risks still persist and Caterpillar’s valuation could swing either way depending on macro conditions.

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