CAT: 5 Reasons to Stay Bearish into 2015

There are more than five reasons, but we will start with these.

S.E.C. Subpoena:  In a Halloween 10-Q filing, CAT disclosed an S.E.C. subpoena from September 10, 2014 saying “…SEC issued to Caterpillar a subpoena seeking information concerning the Company’s accounting for the goodwill relating to its acquisition of Bucyrus International Inc. in 2011 and related matters. The Company is cooperating with the SEC regarding this subpoena and its ongoing investigation. We currently believe that this matter will not have a material adverse effect on the Company's consolidated results of operation, financial position or liquidity.”  We reviewed this accounting issue in the summer of 2013 CAT Short Review: Short Thesis, Long Tail: Replay: CLICK HEREMaterials: CLICK HEREInvestors love S.E.C. subpoenas and potential restatements.

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Oil Price Decline:  Oil & Gas is a large, high margin end-market for CAT.  After the collapse in mining equipment demand, CAT management directed attention away from Resource Industries and toward Energy & Transportation.  We continue to think that will prove an error.  On their earnings call, CAT commented that “the feedback we've been getting that say, mid-$80s - say $80 to $90, somewhere in there on a sustained basis, certainly will take the really agitated top off of it. …. I think if you'd see low $70s on a sustained basis there would be a chill across the market.   Markets are closer to the “chill” level now and time will tell if it is on a “sustained basis”.  Still, it sets up what are likely to be tough comps for E&T in 2015, which already had tough comps elsewhere.  Our recent call on tight oil suggests the chill may not thaw soon.  

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Mining Can Get Worse:  Mining capital spending may be at or near a bottom, but results from Resource Industries can get worse.  We expect pricing pressure, which was mentioned in the 3Q 2014 earnings press release, to persist.  Orders in revenue likely reflect better pricing than those backlogged in today’s weaker market.  With mined commodity prices continuing to see pressure (e.g seaborne iron ore under $80/t) and MATS rules set to impact coal in 2015, idled equipment may well be parted out or resold/repurposed.  CAT Financial may be impacted if used equipment prices decline, potentially exposing the receivables portfolio to losses.  As we understand it, not all of CAT’s mining exposure is categorized under the “Mining” section of CAT Financials disclosures, as much of it is presented by geographic region.

 

Tier IV Pre-Buy:  While the locomotive pre-buy ahead of new emissions regulations was largely telegraphed and quantified at “less than 2% impact on Energy and Transportation” next year, the rest of the Tier IV impact was not.  We expect to see an impact on larger gensets and other very large engines in 2015.

Inflated 2015 Estimates:  CAT hasn’t guided revenues conservatively in recent years, with the 2014 top line mid-point staying constant since last October.  Given the evaporation of Resource Industries, likely pressure on Energy & Transportation (Tier IV, Lower Oil), and tough comps in Construction Industries (dealer inventory build, record margins), flat revenue growth seems reasonable, and perhaps aggressive, in 1H 2015.  The street lowered 2015 sales estimates a bit following the guidance, but remains above guidance (consensus at ~$56.9 bil vs. guide of ~$55 bil).  EPS are expected to grow to an adjusted $7.00 from an estimated $6.50 in 2014.  By our initial estimates, CAT would have to buy in a huge amount of stock to get there.  

CAT: 5 Reasons to Stay Bearish into 2015 - wrf3