CAT: Feeling Managed?
Investors frequently like names that respond well to disappointments. However, CAT’s report is just the latest in a series of guidance cuts driven by a multi-year decline in resources-related capital investment, in our view. Resources-related capital equipment dominates CAT’s operating profit picture and it is not likely to rebound in 2013, 2014 or 2015, in our view. Buying cyclicals that are just past peak results is unlikely to work out well. We still think investors should avoid the long side and look to opportunistically enter short positions.
- Sandbagged Quarter? CAT’s earnings release read very weak today - almost too weak. CAT could presumably have drained backlogs to improve sales, as it has done in other recent quarters, but instead allowed backlogs to build slightly. It seems almost intended to reset expectations lower and make people feel like this quarter was the ‘bottom’. CAT also apparently took an unquantified charge for an unspecified Power Systems project that has yet to be delivered. That seems odd to us, since our recollection of multiple deliverables accounting would have had the negative impact recognized over the remainder of the project through delivery. Not that we are challenging the GAAP-ness of it being in a single quarter, but it suggests to us, at the margin, that management wanted to bring expectations down. They have been letting us down easy, as we previously noted here, but today was a bigger chop.
- What It Means For 2013: Ballpark annualized 1Q performance comes out to roughly $52-$56 billion in sales, by our estimates. CAT can probably hit its new $57-$61 billion guidance range by resuming the draw on its backlog.
- Not Sure About $7: It is not clear to us that CAT can earn $7 with the expected declines in high margin Resource Industries revenue, and the margin compression across Construction Industries and Power Systems. Higher order rates in Construction Industries are negative for mix. We get a likely range solidly below $6/share, with some wiggle room on the tax rate and other assumptions. An $87 million tax benefit this quarter (related to a prior period) helped cushion the decline in operating income and should really be backed out.
- Focus Now 2014: Can CAT earn the current consensus of $9 in 2014? We think not. Consensus seems to be expecting a bounce back in mining and resources-related capital spending. We expect end-market demand to actually worsen in these markets in 2014, as discussed in our recent black book on Mining & Construction Equipment. Ping us if you expect a different outcome – we love the debate.
- 2015 Guidance Off the Table? This may end up being a record for a major company to ditch a long-term profit goal – it was put out only about 7 months ago. It is no doubt embarrassing for management and we do not want to pick on them, aside from noting that the large and expensive mining-related acquisitions will now benefit the “next generation” of management, according to today’s call. Also on the earnings call, management said “I mean, certainly, we don't have an outlook for 2014.” If you do not have an outlook for 2014, how can you have one for 2015?
Source: CAT Mine Expo Analyst Presentation
- Recent Decline in Commodities: Resource Industries and Power Systems sell to resource-related industries, like energy and mining. They also account for about three-quarters of CAT’s operating income. The recent broad decline in commodity prices is likely to impact orders negatively in coming quarters. So far, US coal has been a key driver of weakness, but recent broader declines should catch-up with implied orders in coming quarters. Our March Mining & Construction Equipment black book focused heavily on the commodity capex outlook.
- Inventories Still A Problem: The headwind to production and margins from the inventory correction is likely to last a while, as we have discussed before. CAT may have lowered the level of inventory, but sales declined more. We’ll learn more about the dealer situation as they report in coming weeks.
- Commentary Didn’t Match Numbers: Construction Industries was the worst performing segment in many ways, with sales down 17% and operating income down 61%. Sales were down in every geographic region. That is ugly – yet management implied that Construction Industries was doing well with backlogs up a bit. Power Systems also showed margin declines, apparently partly related to a project problem and its own significant sales decline. Every segment showed sales declines in every geographic region – oddly except mining-heavy Resource Industries in Latin America (+10%!). The weakness was surprisingly broad-based but the commentary fixated on mining equipment. Commentary that does not match the numbers is not a good sign for investors, in our view, as it suggests management is weaving narratives instead of reporting results, essentially managing investors instead of just the business. Today’s proxy, however, suggests that managing investors remains quite lucrative. We are looking forward CAT dealer reports and the CAT 10-Q.