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CAT | Tardiness (Preview)

“And again, we don't ever provide a forecast of what we might or might not do with stock buybacks. We've done a fair amount already and it's our lowest priority.” - Richard Moore 12/1/2015

  

Takeaway:  Within the current reporting framework, we would have looked for a 2016 guide between $3.00 and $3.50.  However, we instead expect CAT to embrace “restructuring”, blurring the line between operating items and one-time charges.  As a recent downgrade suggests, CAT’s 2016 guidance is a widely anticipated negative catalyst.  In the short-run, the ride for shorts may get a bit choppier.  We are focusing on short opportunities in the supply chains of resource-related capital equipment suppliers, where investors have less visibility and more room for downside surprise.  While we do not think that the CAT short is over, it is important to recognize that under ~$60 is potentially “overshoot” territory.  Of course, the shares can overshoot to the downside for quite a while.  

 

 

Key Earlier Publications

 

 

Late Downgrade, Old News:  The Goldman downgrade of CAT reads like a really old newspaper to us, with the exception of an anticipated decline in Solar turbine (gas compression) sales.  Sure, mining and energy capital spending are declining from a massive boom and have further to go…that is why CAT shares have performed so poorly since 2012.  While we highlighted “bubblish” compression activity for Solar in our June “CAT | Feeling Used” deck, it has yet to happen (slide below).  The report misses a number of significant, forward-looking reasons to be negative on CAT including Cat Financial. 

 

 

Some Reasons To Stay Bearish on CAT

  • Used Equipment Overhang: Allows for sustained below trend new equipment & aftermarket parts sales
  • Losses At Cat Financial:  Management just held an analyst meeting that said Cat Financial was in great shape, but we don’t see that as entirely accurate
  • Rail In Addition To Solar: Rail volumes are down, which should meaningfully impact Progress & EMD
  • Buyback Is Dead:  Buybacks are CAT’s “lowest priority” for excess cash (now that the stock is down)

 

 

Blurred Lines Help Adjusted EPS:  In the short run, pressing a CAT short is somewhat riskier.  While we do not think that the CAT short is over, it is important to recognize that under ~$60 is potentially “overshoot” territory.  Of course, the shares can overshoot for quite a while. 

  • The 2016 guide is a widely anticipated negative catalyst. 
  • CAT management has finally got around to adopting the troubled industrial playbook.  They are doing more small acquisitions, taking very large restructuring charges, and finally cutting costs/capacity.  CAT is guiding to $800 million in restructuring charges for 2015 alone.  The line between operating and restructuring can blur when the opportunity to hit consensus expectations is on the line, and $800 million buys a lot of greased, rose-colored lenses. 

 

 

Chunking 4Q ’15 & Guiding 2016?  We get $0.68 cents for CAT’s 4Q EPS ex items, and between $2.90 and $3.25 for 2016.  Both are below consensus, and both may prove irrelevant if CAT changes the reporting game; it would be wise to do so.  An annualized 3Q 2015 plus the expected cost reductions of $750 million actually produce an above consensus ~$4.00 number.  If CAT guides in-line with the ~$3.50 consensus, ex-restructuring charges, the shares may well rise and management can get some breathing room.  Of course, the GAAP 4Q 2015 print should be fairly horrific.

 

 

What About Cat Financial?  Oddly, the GS report doesn’t deal with Cat Financial.  We held a call with an Australian insolvency attorney last week, and were informed that Australian mining equipment lenders are “basically taking losses every day”.  We have been tracking the accumulation of used inventory, which is likely to depress collateral values.  Lower equipment residuals and resource-related bankruptcies will impact CAT later than the drop in orders and new equipment sales.  CAT actually changed its reserve assumptions in 3Q 2015, lowering reserves. We expanded on that here http://app.hedgeye.com/feed_items/47347.

 

(Cat Financial in court right around that November Analyst Meeting)

CAT | Tardiness (Preview) - CAT 1 25 16

 

 

(Used equipment remains an overhang)

CAT | Tardiness (Preview) - CAT 2 1 25 16

 

 

Solar Turbines:  Expectations of capital spending cuts for midstream players have accelerated with the continued MLP bubble unwind.  While this business is likely to continue lower over the next several years, Solar’s non-dealer distribution model allows for the retention of lucrative aftermarket sales.

 

CAT | Tardiness (Preview) - CAT 3 1 25 2016

 

 

Upshot:  Within the current reporting framework, we would have looked for a 2016 guide between $3.00 and $3.50.  However, we instead expect CAT to embrace “restructuring”, blurring the line between operating items and one-time charges.  As a recent downgrade suggests, CAT’s 2016 guidance is a widely anticipated negative catalyst.  In the short-run, the ride for shorts may get a bit choppier.  We are focusing on short opportunities in the supply chains of resource-related capital equipment suppliers, where investors have less visibility and more room for downside surprise.  While we do not think that the CAT short is over, it is important to recognize that under ~$60 is potentially “overshoot” territory.

 

 

 


Cartoon of the Day: A Sinking Ship?

Cartoon of the Day: A Sinking Ship? - liquidity trap cartoon 01.25.2016

 

"Unfortunately, Illiquidity (institutional investors can’t get out of small/mid cap equity and junk bond exposures) and Leverage (hedge funds running 150-250% “gross long”, growth slowing companies like IBM levering up to buy back stock, the largest $ amount of corporate credit outstanding in human history, etc.), wasn’t objectively discussed @Davos." - Hedgeye CEO Keith McCullough, Early Look.


McCullough: Beware The No-Volume Liquidity Trap

 

In this brief excerpt of The Macro Show today, Hedgeye CEO Keith McCullough cautions on Friday’s market “bounce” and how the Federal Reserve, ECB and BoJ “can’t centrally plan volume.”


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Nice! Old Wall Has Second Thoughts About Fed's December Rate Hike

Takeaway: As Wall Street consensus debates whether the Fed rate hike was a 'policy error,' we're pivoting to our next macro call: U.S. #Recession.

Nice! Old Wall Has Second Thoughts About Fed's December Rate Hike - Rate hike cartoon 11.06.2016

 

Is the Fed tightening into an economic slowdown? That's the latest question macro market consensus is grappling with this year.

 

For months now, Hedgeye CEO Keith McCullough has been vocalizing his concerns about flagging U.S. growth while Wall Street all but cheered for a Fed rate hike in December.

 

Watch McCullough Explain our thinking on Fox Business: 

 

Old Wall is now having second thoughts. Here's the latest summation of macro consensus from the Financial Times:

 

Nice! Old Wall Has Second Thoughts About Fed's December Rate Hike - ft policy error

 

"... The long-awaited rate increase went smoothly, but simmering concerns over China, the global economy as a whole, deflating commodities and financial market valuations have since risen to the fore. Even fund managers that were relaxed about slightly tighter monetary policy last month are now wondering whether that was complacent."

 

We've been arguing our Macro themes global #GrowthSlowing#Deflation and #LowerForLonger (rates) for a while now. It appears those realities are slowly dripping into Old Wall consciousness this year, even though we've held them forth for more than 18 months now. 

 

No worries. 

 

We're happy to keep front-running consensus. Our next big Macro theme: U.S. #Recession. Watch the video below in which McCullough and Senior Macro analyst Darius Dale lay out the call on The Macro Show:

... And Watch out!


Recession Watch | WSJ: "This Time Is Different," Hedgeye: "Nope"

Takeaway: WSJ says recession signals are rolling over but argues "this time is different." We disagree.

Perhaps you saw this headline from the Wall Street Journal over the weekend.

 

Recession Watch | WSJ: "This Time Is Different," Hedgeye: "Nope" - wsj recession story

 

Notwithstanding the headline, the story is seemingly amenable to one of Hedgeye's latest Macro calls – the increasing likelihood that the U.S. slips into a #Recession in 2016.

 

Then, about halfway down, WSJ holds up the old "ex-Energy everything is fine argument." That was Old Wall's favorite line last year for explaining away why client equity portfolios were crashing. It's false.

 

Here's Hedgeye CEO Keith McCullough in the video below on this ex-Energy fallacy.

 

Now, the WSJ hangs the rest of its analysis on the jobs market – which is "growing briskly" – and supposedly strong consumer confidence. The mistake here is in confusing absolutes with what really drives macro markets and is ultimately more predictive – rate of change.

 

In the video below, McCullough also dispels of these consumer confidence and jobs market narratives.    

 

Bottom line: Old Wall needs to believe "this time is different" but economic reality always wins out.

 

 


INSTANT INSIGHT | Oil, Volatility & Old Wall Storytelling

Takeaway: Last week's two day rally in equities was not the bottom for which so many were hoping.

INSTANT INSIGHT | Oil, Volatility & Old Wall Storytelling - bears in car cartoon 01.21.2016

Beware the bounce.

 

No, last week's two-day rally was not a sign that the equity crash bottomed out. Heightened volatility should continue to ravage financial markets.

 

Here's analysis from Hedgeye CEO Keith McCullough in a note sent to subscribers earlier this morning:

 

"... After a 2-day bounce in oversold beta all of the bottom callers came back, but day 2 of that came on one of the lightest US Equity Volume days of the year (-9% vs 1-month average). Front-month VIX didn’t come close to breaking any lines of support."

 

On a related note, Oil volatility is ramping too, as crude prices continue their downward descent this morning. 

 

"Oil led the bounce (that hasn’t been a good thing for 18 months) +5.9% on the week for WTI, but is straight back down -3% this morning after failing at all lines of @Hedgeye resistance – risk range there = $28.21-32.68; Oil Volatility (OVX) = 62!"

 

 

Keep your head up out there and beware of Old Wall's shape-shifting storytelling.


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