CAT: Back-end Loader Digs Through Backlog
CAT provided back-end loaded 2013 sales guidance and reported a significant draw down in backlogs. New orders in 3Q were very weak, running over 30% below sales. CAT dealers are adjusting inventories down for a reason, and it is not a bullish end-market order rebound outlook. We think that the bubble in resources investment will take a long time to be fully priced into CAT’s share price. Importantly, CAT’s orders and backlogs have collapsed without an obvious global recession.
- $5.1 billion Backlog Draw: If an investor’s long thesis is that CAT can ride its large backlog through a downturn, that thesis is now being tested. Backlogs fell $5.1 billion in 3Q 2012, so CAT chewed through 18% of the backlog in just one quarter.
- Orders Far Below Sales: The new order rate was only about 2/3 of sales. Without the draw on backlog, CAT was at an $11.3 billion order run rate vs. a reported $16.4 billion 3Q topline. To us, that seems a very wide gap in a single quarter to blame on dealer inventory reductions.
- CAT IS Expecting A Recovery, In Our View: Orders must rebound for CAT to come anywhere near its 2013 sales guidance, in our view. The company noted that dealer orders are below deliveries, but deliveries are the product of end-market demand some time ago. Deliveries lag, orders lead. Dealer orders and inventories respond to end-market orders, not end-market deliveries. Put another way, orders would need to rise nearly 50% for the company to hit its new sales guidance!
- Capacity and Inventories High: CAT’s own inventories continue to look bloated to us and the company will likely have to curtail production capacity, which it has started to discuss in this release, if orders do not rebound sharply. That would likely lower margins from their current, multi-decade peak.
- Long Cycle: Trying to guess when to re-enter CAT is like trying to figure out when to buy CSCO in the early part of the last decade, in our view. The mining and resources capital investment bubble appear quite large and may take years to run off. We see CAT’s fair value in the $40-$70 range and we would wait until we were at the bottom of or below that range to enter the shares. Cyclically adjusted valuation is key, in our view.
- Bear Thesis Intact: We continue to expect CAT to struggle with collapsing resource capital spending, excess inventories and excess capacity. At the margin, we are a bit surprised at the weakness in CAT’s order activity. We expect order deferrals to change to cancellations as contract delay options expire. The company is letting us down easy, but it may feel like death by 1000 cuts.
Please see our September 14th CAT Black Book for additional details on our CAT thesis.
Jay Van Sciver, CFA
HEDGEYE RISK MANAGEMENT
120 Wooster St.
New York, NY 10012