Down The Chain: CAT Dealer Results & Thesis Update

Takeaway: Dealer results leave us to question whether a rebound in orders to "end-user demand" would be such a positive for $CAT.

Down The Chain:  CAT Dealer Results & Thesis Update


We continue to think that Caterpillar’s results are at or near a cyclical peak driven by recent bubble-like capital investment by basic resources companies.  Importantly, we see ongoing evidence suggesting that the cycle has turned and will remain weak for a prolonged period.  Dealer results, discussed below, add to our concerns.  Consensus estimates for 2013 have declined significantly since our 9/14/2012 Black Book and the share price is lower.  While this leaves us a little less bearish, we see continued downside.  In our view, there are less risky investment opportunities on the equipment side in Paccar, and in the sector more broadly in FedEx.


Recent improvements in Chinese data suggest that its economy is in a bottoming process (see work by Darius Dale and Hedgeye Macro team).  While this may be the case, land sales by area are still down a mid-teens percentage YoY.  Local metals prices point to ongoing weakness in Chinese construction, a key end-market for mining.  Chinese average real rebar prices have lurched back below their 2009 lows in recent weeks.


Down The Chain:  CAT Dealer Results & Thesis Update  - cat1



Deep Cyclical

Caterpillar is a capital equipment supplier to highly cyclical end-markets, especially mining.  Capital spending at cyclical companies tends to be more cyclical than the top-lines themselves.  Considering this, buying into an earnings peak at CAT seems like a mistake.  Down cycles can be long-lived.


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Estimates Up & To The Right


Consensus tends to simply extrapolate recent results higher.  While this forecasting method is unlikely to work well for most companies, the results are particularly inaccurate for cyclicals.  Currently, estimates extrapolate near-peak results.  Taking a multiple of estimated earnings is not a robust valuation approach, in our view.


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Dealer Results Look Like CAT’s Results

CAT’s backlog declined during the past two quarters, supporting reported sales and profits relative to orders.   Implied orders in 3Q 2012 were at the lowest percentage of trailing sales since the financial crisis.   Orders tend to lead deliveries and revenues for obvious reasons.  Interestingly, the quantity of long-term orders as a percentage of total backlog at CAT has also nearly doubled from 13.4% in 4Q 2011 to 22.5% at the end of 3Q 2012.  That suggests orders might be at risk of cancellation as customers exercise delay options, in our view.


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CAT Dealer Orders Deteriorate

Caterpillar dealers have served the company well over the years and have carved out a nice return for themselves in the process.  A number of dealers are public, allowing insight directly into customer activity.  Recent results suggest that end-user order activity has declined significantly.  CAT management has said that “end-user demand” is more robust than current CAT orders based on dealer deliveries.  However, this seems somewhat misleading because dealer deliveries lag dealer orders.  CAT’s comments imply that revised 2012 and 2013 guidance is the product of dealer inventory adjustments and Caterpillar orders will soon return to high levels (“end-user demand”).  From CAT’s 3Q 2012 10Q:

“Dealer reported new machine inventory increased about $400 million during the third quarter of 2012 compared with an increase of about $675 million during the third quarter of 2011. Dealer machine inventories at the end of the third quarter of 2012 are higher than historic averages relative to dealer deliveries to end users. Dealers have substantially lowered order rates below machine deliveries to end users, which we expect will result in dealer inventory reductions in the fourth quarter and continue into 2013. As a result of the anticipated reductions in dealer inventories as well as global economic conditions that are weaker than previously expected, we are lowering production in many facilities around the world. Lower production levels will continue until inventories decline and dealer order rates increase and are more in line with end-user demand.” – CAT 3Q 2012 10Q Page 57


However, implied order activity at the dealer level in the results we have seen suggest that end-user demand has weakened significantly.  Backlogs have come down at the dealer level, too, sustaining current deliveries.  Dealers do appear to have too much inventory, but they also appear to have suffered a significant order decline.  That one/two punch will further push down CAT 2013 revenue and profit estimates, in our view.


Finning: New Equipment Implied Orders Down 45% YoY in 3Q 2012


Finning, like Caterpillar, drew down backlogs last quarter.  Backlogs for new equipment fell from $1.7 billion to $1.4 billion, with sales in the quarter at $723 million.  Implied orders were only ~$423 million in 3Q 2012 vs. ~$760 million in 3Q 2011, a 45% drop, by our estimates.

[The] Company is focused on reducing uncommitted inventory levels and prudently managing working capital.” – Finning 3Q Filing


Wajax: Oil, Gas and Mining Weakness


Wajax is a smaller Canadian dealer than Finning and has shown similar business trends.  The company noted weakness in oil and gas orders, which was of particular interest since many investors expect this area of CAT’s business to hold up well.

“Overall backlog declined primarily as a result of a reduction in customer orders in the mining and oil and gas sectors…While the number of outstanding quotes for mining equipment continues to be significant, customers have been delaying their purchasing decisions in the face of lower commodity prices…Looking forward we expect softness in the oil and gas and mining sectors to continue into 2013.”  - Wajax 3Q 2012 Release/Filing


The Bull Story at Sime Darby: It’s Just Like the 2009 Global Financial Crisis (?)

In a recent presentation, Sime Darby, an Asia-based conglomerate with a large CAT dealer network, suggested that the current situation was similar to 2009.  We disagree, since the present environment looks nothing like 2009.  In 2009 the order decline was driven by a global financial crisis, which is absent today.  The current order declines have been driven by underlying market weakness following a decade of over-investments, in addition to stimulus spending roll-off, in our view.


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Sime Darby reports in late November, and we will be interested in the results and will look for updates to this bull rationale.


Jay Van Sciver, CFA

Managing Director

120 Wooster St.

New York, NY 10012



We haven't run the regression but we're pretty sure the correlation of male smokers to gamblers is pretty high. It's looking more likely than not that the smoking restrictions will go into effect in January. 



While there might be a delay in the implementation of the new smoking rules from January 1st to January 14th, it is unlikely the casinos will be able to successfully lobby for any further delay.  Once implemented, we believe there will be a major impact on the main gaming floor on table efficiency and labor costs as casinos will have a lot more players per table on the smoking tables.  It is unknown yet whether the casinos will be allowed to push less productive games into the non-smoking section or if regulators will require an equal distribution.


While the new smoking restrictions will likely supress demand and maybe impact margins, we don't believe there will be long-term ramifications.  However, we would caution that Q1 could be disappointing.  Since only the main gaming floor will be impacted, LVS and SJM could be the most at risk due to their Mass based business model.  LVS has built the most spacious gaming floors so that should alleviate some of the productivity issues.  Moreover, LVS is still ramping with Cotai Central and we think it's overall share will continue to grow to the low to mid 20s.


An order from the Macau CEO regarding the smoking ban was published in the Macau Gazette on November 5th and is summarized below:

  • Rules apply to all table games and slot machines
  • Smoking areas cannot be greater than 50% of the total area for the public
    • This rule excludes non-gaming establishments
  • Smoking areas must display the following:
    • Posters addressing no-smoking zones
      • Label with minimum dimension (40cm x 30cm) in Chinese, Portguese, and English 
    • Separation from other installations
    • Ventilation systems
  • Smoking area locations
    • In casinos with several floors and an atrium, smoking areas should be located on the upper floors
    • In casinos with a single floor, smoking area must be located opposite and separate from the non-smoking area.
  • Non-smoking areas can be achieved through the following measures:
    • Air curtain system
    • Transition area with inflation system
    • Transition area of at least 4 meters
    • Installation of a wall or fence with a minimum of 2 meters

WEN: Can We Get A Pulse?

Wendy’s (WEN) just announced it would be doubling its dividend and initiating a $100 million stock repurchase program. While that’s nice for existing shareholders of record, the truth is that the company has better uses for that amount of cash. WEN’s stock fell in 2007 through 2008 and has flatlined since. This stock is in dire need of some kind of boost as it continues to trade in a tight range year-after-year.


WEN: Can We Get A Pulse? - WENDYS

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Genting Singapore’s numbers came in-line with our expectations.  While the official consensus number hasn’t changed since early October, whisper EBITDA was close to the reported S$300MM.  We don’t have a call on the stock right here, but thought it may be helpful to provide a little more detail on the quarter given the opaque nature of the company’s reporting.



3Q12 Detail

  • Gross gaming revenue of S$797MM on net gaming revenue of S$528MM
    • Rebates, GST & mass marketing points of S$269MM; equal to 33.7% of GGR  (slightly down from the 33.8% in 2Q12 but up from 31.8% in 3Q11)
    • Gross VIP revenue of S$363MM and net VIP revenue of S$190MM
      • Just to clarify, when the Company says that Net RC revenues are 28% of Net Casino revenue, they are not just referring to the rebate on VIP but ALL discounts offered on gaming play (ie, Rebates, Mass points, GST, comps, MVP’s and other).
      • 45.5% of GGR
      • RC turnover:  S$13BN (just under) down 20% YoY and 2% QoQ
      • Hold rate:  2.8%
      • Rebate:  1.33% or S$172MM, down from 1.36% last quarter but up from 1.32% last year
  • Mass win of S$285MM down 9% YoY and up 1% QoQ
    • Drop of S$1.24BN and hold of 22.9%
  • Slot & ETG win S$150MM
    • Handle down 4% QoQ to S$2.95BN and 1% YoY
  • Expenses:
    • Gaming tax:  S$78.5MM
    • Estimated fixed costs:  S$198MM, down from S$217MM in 2Q12

Restoration Hardware Q&A

Today, we held a call with Hedgeye Retail Sector Head Brian McGough on Restoration Hardware’s (RH) upcoming IPO for Retail Pro subscribers. McGough covered everything from growth to target markets to financial difficulties. We’ve provided the Q&A portion of the call for you to enjoy. If you’re interested in becoming a Retail Pro subscriber, please visit this webpage.




Takeaway: MGM could continue to be under pressure

Keith shorted MGM in our Real-Time Positions at $9.95.  MGM's TRADE and TREND resistance is at $10.29 and $10.76, respectively.



As MGM nears its 52-week low, we think there is further room to the downside.  A difficult macro environment and a secular decline in slot demand should continue to pressure results.  We're below the Street on Q4 and 2013.  Slot volumes, which we believe is the ultimate barometer of the health of Vegas, have fallen in five out of the last six months.  According to our trend projection model, we expect the downward trend to continue for the rest of 2012.  September was up slightly but the month contained two extra weekend days - a calendar boost that will reverse in October.  Management did say they are seeing better Strip trends in early Q4 but they said the same last quarter and missed expectations badly.   



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