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CAT: Annoying Set-up, Cracks At Cat Financial?

(note: delayed because of an earnings season bout of stomach flu.)

 

Overview

 

The mining downturn showed CAT’s executives the importance of managing Street expectations.  CAT stands a good shot of earning between $4.50 and $5.25 this year, and those odds increased with 1Q15 results.  Estimates for 2016 EPS are now slightly below those for 2015, even with an aggressive buyback program.  Despite an achievable bar, management commentary was decidedly downbeat.  The delusional optimism is now gone.  Bummer.  Comments like this were more fun:

 

“That’s the reason back in 2010 we said that we were going to invest heavily in mining, and yes we did, in terms of our acquisitions and our R&D and our capital we invested over $15 billion and everybody will see over the long term that that was an outstanding investment.” – Steve Wunning 3/4/14

 

 

We have three takeaways from the quarter:

  1. Cat Financial Showing Cracks?  Cat Financial had performance issues in its Latin American and Mining portfolios.  Mining and Oil & Gas credit trouble is our next potential downside catalyst.  Remarketing equipment would be no picnic in either industry.  For background on our concerns, see here, and we expect to have more detail on Cat Financial in the next couple of weeks.
  2. Implied Orders Weak, But Biased by Cancellations:  End-market demand was much weaker than either reported sales or full year revenue estimates.  However, book-to-bill type metrics may be artificially depressed due to oil & gas order cancellations.
  3. CI, E&T Margins Quite Good:  CAT performed well with what it had, and that, along with a low 2Q15 bar, may keep us sidelined for now.  We had anticipated placing short CAT back on our Best Ideas List, after having removed following a weak 4Q14 earnings report in January.

 

Frustrating Set-up, Waiting Until Closer to 2Q 2015:  CAT may be able to meet or beat 2Q15 estimates, and again inch guidance higher.  We would guess that management didn’t raise guidance by the full beat because they wanted to keep expectations low heading into a far weaker 2H 2015 environment.  We’d also bet that the company’s “actual” internal forecast has them crushing their “publically discussed” internal forecast.  We have been expecting to re-enter a CAT short view, as discussed in our 1Q15 earnings preview note, but will now likely wait until either just before or just after 2Q15 results.

 

 

CAT Not Out of the Woods

Cat Financial Showing First Cracks:  CAT noted that “At the end of the first quarter of 2015, past dues were 3.08 percent, compared with 2.17 percent at the end of 2014. The increase in past dues compared to year-end 2014 was primarily due to the performance of the Latin American and Mining portfolios and seasonality impacts.”  We think this might be the next key downside catalyst for Caterpillar, and one that could represent ‘the bottom’ – that, or perhaps a management changeWe will have more to say about Caterpillar Financial in coming weeks.  .

 

CAT: Annoying Set-up, Cracks At Cat Financial? - mn1

 

 

Implied Orders Below Revenue, Estimates:  The mining downturn is now better appreciated, including expectations for price competition and negative RI operating margins.  CAT’s exposure to Oil & Gas is also well recognized now, even though it won’t really hit results until 2H 2015. Still, if we look at the end-market order rates implied by quarterly sales, adjusted for backlog and dealer inventory changes, CAT reported a book-to-bill like metric well below 1.00 (~0.86 in 1Q 2015 vs. ~0.98 in 1Q 2014).  Does this suggest downside risk to revenue in the longer-term?  Maybe, but we would bet that cancellations had a non-recurring and disproportionate impact.

 

CAT: Annoying Set-up, Cracks At Cat Financial? - mn22

 

 

Segments

 

Construction Industries (CI):  CI benefitted from a larger inventory build at the dealer level than the company has seen in recent years, but only about $100-$200 million more than last year by our rough estimates.  Pricing and currency were also benefits.  Regardless, it is hard to spin 220bps of margin improvement on a 7% revenue decline as some sort of negative.  Of course, we expect margins to decline during next three quarters of 2015, much as they did last year following strong 1Q results and dealer inventory builds.

 

CAT: Annoying Set-up, Cracks At Cat Financial? - mn3

 

 

Energy & Transportation:   E&T should run through its high margin, at risk oil and gas backlog by the end of 2Q15, and back half 2015 margins should suffer as a result.  Still, an operating margin in the 15%-16% seems reasonable in 2H.  We suspect, although the company has not indicated as much, that deposits for cancelled orders may have boosted results somewhat.  Also, close in orders (inside 90 days, or so) are typically unable to be cancelled.  Those two factors suggest margin slippage in 2Q 2015, ahead of the 2H 2016 profitability stepdown.

 

CAT: Annoying Set-up, Cracks At Cat Financial? - mn4

 

 

Resource Industries:  Earnings call commentary indicated that segment operating losses would like;y come later this year.  The industry is capital intensive industry and has excess capacity, and we have been expecting price competition to heat up. 

 

CAT: Annoying Set-up, Cracks At Cat Financial? - mn5

 

 

Upshot


We learned last year, quite painfully, to be careful of CAT management’s plans to guide low and ratchet expectations higher.  With 2015 and 2016 estimates already fairly low, we need to build our case for meaningful credit losses at Cat Financial.   We will stay on the sidelines until we get closer to the 2Q 2015 results, which could again provide CAT with the scope to nudge guidance higher.  

 

 

 



Cartoon of the Day: Shed a Tear for OPEC

Cartoon of the Day: Shed a Tear for OPEC - OPEC cartoon 04.24.2015

The collapse of the cartel grows closer. Poor guys.


Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.

Crude Oil Update: Thoughts on the Counter-TREND Move

Takeaway: We reiterate our bearish intermediate to long-term view within a myriad of conflicting signals.

In the video below and its accompanying slide deck, we weigh-in on conflicting top-down market signals and touch on the push and pull in global supply/demand dynamics.

 

 

CLICK HERE to download the associated presentation.

 

As, always we appreciate any comments or questions coming our way. 

 

Ben Ryan

Analyst


Amazon: $15 in EPS by 2018? | $AMZN

Editor's Note: This is an excerpt from a research report written earlier today by Hedgeye Retail Sector Head Brian McGough. Click here for more information on how you can subscribe to our services.

*  *  *  *  *  *  *

It's tough to say that this was a 'great' quarter for AMZN, as the company still lost money despite adding $3bn in revenue and improving gross margins by 340bp. But relative to expectations, it was killer.

 

Specifically, EBIT came in at $255mm, which compares to guidance of -$450mm to +$50mm. That's particularly impressive given that the international business posted a 1600bp hit in reported sales growth due to FX -- the biggest hit ever for AMZN. 

Amazon: $15 in EPS by 2018? | $AMZN - 1 amzn 

When all is said and done, we think that the AMZN debate is finally getting interesting. It's been a stock that trades at a stratospheric multiple of earnings (about 370x today), but invests and competes away its profit/earnings to gain share. By our math, today AMZN accounts for about 15% of all online spending. At some point sales growth will slow, share will find its final resting place, and AMZN will blow-out its margins. That's when we see the real earnings power of the company. Looked at a different way, Wal-Mart accounts for about 7% of Brick & Mortar US Retail Sales. Based on that metaphor, one could make the argument that AMZN is twice as dominant in its core market as WMT is.

 

The bull case as we see it is that AMZN tops out at 20-22% of Online Retail Sales over 3-4 years, and takes margins up to 6% -- something that's well within reason. This year the company will earn something south of a buck. But a 6% margin in 2018 would result in EPS of about $15. That's about 25x earnings based on today's price. Not bad for one of the most dominant companies to ever do business on this planet.

Amazon: $15 in EPS by 2018? | $AMZN - z amzn


Greece, Earnings and Germany

Client Talking Points

GREECE

The news for Greece remains primarily negative, no reform list has been submitted by Greece which is a big issue for the Eurogroup. A Eurogroup Chair member came out and said there are still wide differences that remain. The Greek Foreign Minister is being criticized by EU colleagues. The one bright spot is that Germany has said that they see some progress being made.

EARNINGS

72% of U.S. companies have beat earnings estimates, which is a positive and in-line with the 5-year average. However, the blended rate of earnings and revenue growth is down -3.4% in Q1 year-over-year. The big driver of this draw down is likely the energy sector.

GERMANY

Germany remains one of our top long ideas in Macro. The recently released IFO data was mixed. IFO’s current conditions index rose to 113.9 in April from 112.1 in March, while a measure of expectations fell to 103.5 from 103.9. The IFO's business climate index rose for a sixth month to 108.6 from 107.9 in March. 

Asset Allocation

CASH 31% US EQUITIES 14%
INTL EQUITIES 16% COMMODITIES 4%
FIXED INCOME 31% INTL CURRENCIES 4%

Top Long Ideas

Company Ticker Sector Duration
MTW

MTW revised down its 2015 guidance for the Foodservice Equipment segment and preannounced a weaker than expected 1Q 2015. Sales in the quarter are a noteworthy miss, but we do not believe that the release has relevance for our sum-of-the-parts valuation thesis, and see many reasons to anticipate stronger operating results in 2H 2015.  Basically, we think investors stand to be paid for suffering through this volatility, with potential share price upside on separation ranging from the high 20s to low 40s. Near-term profit weakness is partly why the shares are ‘cheap’, and we think holders may be compensated well for the volatility. The shares are currently trading lower on a weaker than expected 1Q15, but 2Q15 should show improved Crane segment results and 2H should show better Foodservice Equipment results.

ITB

iShares U.S. Home Construction ETF (ITB) is a great way to play our long housing call. The housing data was mixed in the latest week with the April homebuilder confidence survey (NAHB HMI) putting in a strong sequential improvement, while March Housing Starts were a bit soft. The National Association of Home Builders (NAHB) released its April Housing Market Index survey (HMI) – essentially a survey of builder confidence. The print was strong as it showed a nice bounce across all three survey categories: traffic of prospective buyers, current conditions, and expectations 6 months out.  Housing Starts were up sequentially in March, but by less than the market expected. Total Starts rose by 2% to 926,000 (seasonally-adjusted annualized rate) from 908,000 in February.

TLT

On the domestic fixed income front we’re looking at lower yields for longer. Lower yields benefit those slow-growth fixed income cash flows tied to the treasury curve (yields down, bonds up). TLT sets-up nicely in a slow-growth, deflationary setting because inflation missing=expectation for even easier policy=more central-planning cowbell=lower yields for longer.

Three for the Road

TWEET OF THE DAY

3.26 million new retail brokerage accounts opened in China . . . . This week ! #TradingTheDragon @HedgeyeDJ

QUOTE OF THE DAY

We are really competing against ourselves, he have no control over how other people perform.

Pete Cashmore

 

STAT OF THE DAY

Roughly 83 million Americans age six and over (about 28% of the population), reported that they did not once participate in any of 104 specific physical activities in the last calendar year which qualifies them as "totally sedentary" (survey results by the Physical Activity Council).


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