“And again, we don't ever provide a forecast of what we might or might not do with stock buybacks. We've done a fair amount already and it's our lowest priority.” - Richard Moore 12/1/2015
Takeaway: Within the current reporting framework, we would have looked for a 2016 guide between $3.00 and $3.50. However, we instead expect CAT to embrace “restructuring”, blurring the line between operating items and one-time charges. As a recent downgrade suggests, CAT’s 2016 guidance is a widely anticipated negative catalyst. In the short-run, the ride for shorts may get a bit choppier. We are focusing on short opportunities in the supply chains of resource-related capital equipment suppliers, where investors have less visibility and more room for downside surprise. While we do not think that the CAT short is over, it is important to recognize that under ~$60 is potentially “overshoot” territory. Of course, the shares can overshoot to the downside for quite a while.
Key Earlier Publications
- Feeling Used? Short CAT Black Book (latest of many)
- Dear Barron’s, “Snap”? Yes. “Back”? Not So Much (8/8/15)
- It Gets Worse From Here (7/23/15)
- Naughty (11/4/15)
- Spin The Buldozer (11/20/15 review of Cat Financial Analyst Day)
Late Downgrade, Old News: The Goldman downgrade of CAT reads like a really old newspaper to us, with the exception of an anticipated decline in Solar turbine (gas compression) sales. Sure, mining and energy capital spending are declining from a massive boom and have further to go…that is why CAT shares have performed so poorly since 2012. While we highlighted “bubblish” compression activity for Solar in our June “CAT | Feeling Used” deck, it has yet to happen (slide below). The report misses a number of significant, forward-looking reasons to be negative on CAT including Cat Financial.
Some Reasons To Stay Bearish on CAT
- Used Equipment Overhang: Allows for sustained below trend new equipment & aftermarket parts sales
- Losses At Cat Financial: Management just held an analyst meeting that said Cat Financial was in great shape, but we don’t see that as entirely accurate
- Rail In Addition To Solar: Rail volumes are down, which should meaningfully impact Progress & EMD
- Buyback Is Dead: Buybacks are CAT’s “lowest priority” for excess cash (now that the stock is down)
Blurred Lines Help Adjusted EPS: In the short run, pressing a CAT short is somewhat riskier. While we do not think that the CAT short is over, it is important to recognize that under ~$60 is potentially “overshoot” territory. Of course, the shares can overshoot for quite a while.
- The 2016 guide is a widely anticipated negative catalyst.
- CAT management has finally got around to adopting the troubled industrial playbook. They are doing more small acquisitions, taking very large restructuring charges, and finally cutting costs/capacity. CAT is guiding to $800 million in restructuring charges for 2015 alone. The line between operating and restructuring can blur when the opportunity to hit consensus expectations is on the line, and $800 million buys a lot of greased, rose-colored lenses.
Chunking 4Q ’15 & Guiding 2016? We get $0.68 cents for CAT’s 4Q EPS ex items, and between $2.90 and $3.25 for 2016. Both are below consensus, and both may prove irrelevant if CAT changes the reporting game; it would be wise to do so. An annualized 3Q 2015 plus the expected cost reductions of $750 million actually produce an above consensus ~$4.00 number. If CAT guides in-line with the ~$3.50 consensus, ex-restructuring charges, the shares may well rise and management can get some breathing room. Of course, the GAAP 4Q 2015 print should be fairly horrific.
What About Cat Financial? Oddly, the GS report doesn’t deal with Cat Financial. We held a call with an Australian insolvency attorney last week, and were informed that Australian mining equipment lenders are “basically taking losses every day”. We have been tracking the accumulation of used inventory, which is likely to depress collateral values. Lower equipment residuals and resource-related bankruptcies will impact CAT later than the drop in orders and new equipment sales. CAT actually changed its reserve assumptions in 3Q 2015, lowering reserves. We expanded on that here http://app.hedgeye.com/feed_items/47347.
(Cat Financial in court right around that November Analyst Meeting)
(Used equipment remains an overhang)
Solar Turbines: Expectations of capital spending cuts for midstream players have accelerated with the continued MLP bubble unwind. While this business is likely to continue lower over the next several years, Solar’s non-dealer distribution model allows for the retention of lucrative aftermarket sales.
Upshot: Within the current reporting framework, we would have looked for a 2016 guide between $3.00 and $3.50. However, we instead expect CAT to embrace “restructuring”, blurring the line between operating items and one-time charges. As a recent downgrade suggests, CAT’s 2016 guidance is a widely anticipated negative catalyst. In the short-run, the ride for shorts may get a bit choppier. We are focusing on short opportunities in the supply chains of resource-related capital equipment suppliers, where investors have less visibility and more room for downside surprise. While we do not think that the CAT short is over, it is important to recognize that under ~$60 is potentially “overshoot” territory.
