CAT: E&T Isn’t Dead, At Least Just Yet (Earnings Preview)

Overview

 

We see CAT roughly matching 1Q 2015 EPS expectations, within a range of about $1.23 to $1.39, relative to consensus of $1.35.  Sales estimates look a bit low to us; we get a sales beat from CAT at >$12.7 billion vs. consensus of $12.3 billion.  We’ll explain that deviation away by assuming CAT management set achievable expectations for 1Q 2015 in order to inch guidance higher during the year.  That strategy worked well for much of 2014, and CAT management seems increasingly practiced in managing street expectations.

 

CAT faces greater pressure in the back half of the year, as oil-related order at E&T backlogs run dry.  The eventual draining of E&T backlogs may foil that strategy, but we think that low 2015 expectations have already shifted the focus to 2016.  Management, we suspect, was looking to set a low bar for 2015; they are unlikely to lower guidance in the 1Q 2015 earnings report, and may well try to shade it a bit higher.  Of course, guessing at quarterly results and commentary is an error prone exercise, and our views should be considered in that context.

 

We wouldn’t exactly run long into the print, and remain negative on the prospects for CAT shares.  That said, we are ‘hoping’ for an in line to better-than-expected result so that we can add CAT back to our Best Ideas List on the short side in anticipation of much weaker 2H 2015 results.  In contrast to what some CAT bears are likely expecting, we see the oil & gas exposed Energy and Transportation segment again leading  CAT’s segment profitability in the quarter.  Of course, we worry that ‘everyone’ is expecting E&T to post a stronger first half.  We come out thinking that the severe 2015 guide down pushed weaker longs out of CAT shares, and even an in line 1Q 2015 result may pull in index sensitive buyers.  If so, that may set up an opportunity for CAT bears, like us, to reenter the name. 

 

We are particularly interested in CAT Financial exposures, as discussed here, here, and hereEncourage your favorite First Call listed sell sider to ask about CAT Financial’s exposure to high cost miners (copper, iron ore, coal etc) and shale oil (pressure pumping, well service etc) companies on the earnings call.

 

For additional background on CAT, feel free to ping us or see here, here, here, or here for some relevant notes.

 

 

 

Segment Highlights

 

Energy & Transportation (E&T):  E&T isn’t dead yet, in part because that demise is expected to be more of a 2H 2015 event.  Backlogs in the segment, even with allowed order cancellations, should protect results through much of 1H 2015.  Dealer sales data for the segment – admittedly narrow in scope – similarly do not point to any significant 1Q 2015 declines.  We would expect CAT to retain some deposits for canceled orders in energy-related large engines, and deposit retention can temporarily boost margins.  CAT is guiding to a 5 to 10 percent segment revenue decline for full year 2015, with much of that weakness (aside from specific issues like Tier 4 locomotives) pushed to the second half.  

 

CAT: E&T Isn’t Dead, At Least Just Yet (Earnings Preview) - f1

 

 

Construction Industries (CI):  CAT has guided for Construction Industries sales to decline by 5 to 10 percent in 2015 from 2014.  Weakness in South America, where a government contract sets up a tough comp, offsetting some expected gains in North America, and, most likely, Europe.  We see CI a bit stronger in 1Q and 2Q, although the 1Q 2015 margin is a pretty-much-all-time difficult comparison. 

 

CAT: E&T Isn’t Dead, At Least Just Yet (Earnings Preview) - f2

 

 

Resource Industries (RI):  This somehow forgotten segment doesn’t suffer from a Fed-like zero bound, and we are interested to see how competitive pricing becomes as 2015 progresses.  We model incremental margin weakness into 2015 as aftermarket sales fail to support activity and excess capacity encourages pricing competition for whatever orders remain.  This segment might suffer from remarketed used equipment later this year, adding pressure to what would otherwise be a stabilizing order environment.  Management is forecasting decline of about 10 percent for segment revenue, but we anticipate the declines more equally spread throughout the year.

 

CAT: E&T Isn’t Dead, At Least Just Yet (Earnings Preview) - f3

 

 

Upshot

 

Relative to the scope of CAT’s recent results, we expect a reasonably in line result from CAT.  Management, we suspect, was looking to set a low bar for 2015 in January;  we think they are unlikely to lower guidance in the the 1Q 2015 earnings report.  Like 2014, management may instead be looking to inch the guidance higher.  We expect that to be easier to do in the first half of 2015, during which the E&T backlog should provide a high margin revenue cushion.  The second half may well provide no such padding, and we will look to use meaningful strength to add CAT back to our Best Ideas List on the short side.  

 

 


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