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CAT | Mismatch Between Cat Financial Trends vs. Used Equipment Values

Takeaway:  While Cat Financial’s year-end credit metrics were better than our expectations, we still expect an impact from lower equipment values and increasingly stressed customers. The Cat Channel appears to be holding units off the market with unrealistic pricing.  Borrower flexibilities with respect to negative equity and skip payment options may be forestalling the eventual impact of weaker end-markets.  Of course, we may also be misreading Cat Financial’s exposures and are continuing a dialogue with management.  While we will not dismiss the disconfirming evidence of favorable portfolio metrics lightly, we still expect an eventual negative impact from pending mine closures, oil & gas bankruptcies, and equipment auctions.

 

 

Overview

 

As we went through CAT’s 10-K, we were struck by steady to improving credit trends at Cat Financial.  Relevant used equipment values have generally been falling, and credit quality in many key customer categories has been deteriorating (e.g. mining, coal, oil & gas, emerging markets).  We view CAT’s reporting as having become more aggressive as the company now risks falling below the key $3.50 EPS compensation threshold.  Switching pension accounting methods and changing receivable loss allowance calculations can add to reported profits.  The credit trends at Cat Financial could be part of the same ‘efforts’.  They also may be a byproduct of a captive finance subsidiary’s role in stabilizing used equipment pricing, which can often prove costly.  Perhaps Cat Financial can navigate the current environment adequately.  We review some details below. 

 

 

Used Equipment Pricing Is Pretty Clearly Down

While it is challenging to determine exact pricing trends in used equipment (i.e. collateral for equipment financings) the changes we track have mostly been negative.  We see more equipment for sale and generally lower prices.

 

CAT | Mismatch Between Cat Financial Trends vs. Used Equipment Values - CAT 1 2 23

 

 

Perhaps unsurprisingly, oil and gas equipment is piling up.

 

CAT | Mismatch Between Cat Financial Trends vs. Used Equipment Values - CAT 2 2 23

 

 

Construction Equipment, Too:  Used equipment pricing pressure isn’t limited to mining and oil & gas equipment.  While we think this chart overstates used excavator price weakness, it seems pretty clear that excavator auction prices have declined in recent years.

 

CAT | Mismatch Between Cat Financial Trends vs. Used Equipment Values - CAT 3 2 23

 

 

Cat Financial Credit Metrics Moving The Other Way

Usually, we would expect used equipment values to correlate with customer creditworthiness, and for both to correlate with Cat Financial’s portfolio metrics.  Interestingly, that is not what we saw in the 2015 10-K.

 

 

Dubious Allowance For Credit Losses:  The allowance for credit losses is down, but this is largely because CAT changed the calculation in 3Q 15 (reviewed here http://app.hedgeye.com/feed_items/47347).  From the 10-K The decrease in allowance rate is primarily a result of changes in our estimate of the loss emergence period and loss given default.”  As we see it, allowance is not sequentially comparable; such historically low reserve levels in the present environment seem dubious at best.

 

CAT | Mismatch Between Cat Financial Trends vs. Used Equipment Values - CAT 4 2 23

 

 

Write-Offs Somewhat Elevated:  We would also note that 2H 15 saw a modest increase in write-offs, which help can improve other portfolio measures by removing troubled loans.

 

CAT | Mismatch Between Cat Financial Trends vs. Used Equipment Values - CAT 5 2 23

 

 

91+ Days Past Due Looks Better:  The past due payments improved sequentially, which is a noteworthy positive.  While higher write-offs help, it is a surprising trend relative to our expectation.

 

CAT | Mismatch Between Cat Financial Trends vs. Used Equipment Values - CAT 6 2 23

 

 

Regional Data Mixed:  Latin America & Europe were worse year-on-year, but North America and Asia/Pacific improved.

 

CAT | Mismatch Between Cat Financial Trends vs. Used Equipment Values - CAT 7 2 23

 

 

Total Past Due Also Improved:  While partly from larger write-offs, total past due also improved sequentially and YoY.

 

CAT | Mismatch Between Cat Financial Trends vs. Used Equipment Values - CAT 8 2 23

 

 

Non-Accrual Status:  The year over year increase decelerated, albeit on a smaller portfolio.

 

CAT | Mismatch Between Cat Financial Trends vs. Used Equipment Values - CAT 9 2 23

 

 

Skip Payments & Consigning Negative Equity Equipment

 


Perhaps Just Delayed:  We would note that Cat Financial generally offers the option to skip payments: “Skip payment plans (up to 3 per year) are available on monthly payment schedules”*, and the ability to offset negative equity in specific equipment with positive equity in a customer fleet.  That said, these factors were also true a year ago.

*https://www.catfinancial.com/en_US/solutions/finance/loan.html

 

CAT | Mismatch Between Cat Financial Trends vs. Used Equipment Values - CAT 10 2 23

 

 

Keeping Used Prices High & The Role Of Captive Finance Subsidiary

 

 

Accumulating Equipment For Sale (Charts Below):  As we have previously noted, used equipment appears to be piling up at CAT Dealers.  Equipment counts and sale durations do suggest to us that CAT is trying to hold prices up in the aftermarket.  Critically, only about 10% of CAT machines are sold by non-CAT auctioneers. Maintaining aftermarket prices is a standard theoretical role for a captive finance subsidiary, partly so used equipment doesn’t compete with new sales. In the face of prolonged end-market downswings, these efforts can prove costly.

 


Auction Results vs. Cat Asking Prices:  Comparing used mining trucks is a bit difficult given specific features, rebuilds, and maintenance histories, but we do not see auction prices that in any way correspond to the asking prices on the CAT Used website.  For example, CAT Used lists the price of a 1999 785C with 61,823 hours (although some zero hour components) at $1,350,000.  That mining truck has been offered at that price in Winchester, VA since at least 2014, when demand for mining equipment was stronger.  Given the coal/mineral mining capital spending environment, it would seem that the likelihood of remarketing the truck at all is low, let alone at a 2014 price.  Looking at Ritchie Bros. auction results, a 2005 785C with 36,759 hours sold for $105,000 in April 2015.  Even since then mining equipment demand has weakened.  Similar comparisons show up for many of the rock/off-highway trucks on the CAT Used site – this one is no way unique.

 

CAT | Mismatch Between Cat Financial Trends vs. Used Equipment Values - CAT 11 2 23

 

 

Raises A Number Of Questions: How is collateral valued if equipment doesn’t receive a bid?  Is this the reason Cat Financial dropped the word “liquidation” from the recent 10-K?  Where would used equipment values settle if Cat wanted to sell more quickly?  How does it make sense to, presumably, shorten the loss emergence period when equipment is accumulating and lingering?

 

 

Liquidation vs. Fair Value:  We questioned CAT management on a seemingly important language change in the 2015 10-K.  The allowance for credit losses on receivables that merit individual evaluation switched from consideration of “liquidation of collateral” to the PV of effective interest or the “fair value”.  In the context of unsold equipment, the change seemed material to us.  When queried, Cat Financial responded with: “The disclosure regarding methodology of allowance for credit losses attributable to specifically evaluated finance receivables does not represent a change in methodology but rather additional disclosure of the methods that we use for evaluation.  The methods disclosed in 2015 are standard practice under US GAAP for evaluating impairment of finance receivables.” Presumably, then, Cat Financial has already been using fair value… The word “liquidation” was removed from the filing.

 

CAT | Mismatch Between Cat Financial Trends vs. Used Equipment Values - CAT 12 2 23

 

 

Accumulating Used Equipment In Cat Channel

CAT | Mismatch Between Cat Financial Trends vs. Used Equipment Values - CAT 13 2 23

 

CAT | Mismatch Between Cat Financial Trends vs. Used Equipment Values - CAT 14 2 23

 

CAT | Mismatch Between Cat Financial Trends vs. Used Equipment Values - CAT 15 2 23

 

 

Closures, Bankruptcies Still Coming: As we understand it (see here for call with Michael Currie http://app.hedgeye.com/feed_items/47572), mines will start to move from idling to closures this year.  Permanent closures, which mostly have been avoided so far, should involve significant equipment liquidations.  Oil & gas hedges will also expire, creating further pressure in an increasingly saturated used equipment market.

 

CAT | Mismatch Between Cat Financial Trends vs. Used Equipment Values - CAT 16 2 23

 

 

Upshot:  While Cat Financial’s year-end credit metrics were better than our expectations, we still expect an impact from lower equipment values and increasingly stressed customers. The Cat Channel appears to be holding units off the market with unrealistic pricing.  Borrower flexibilities with respect to negative equity and skip payment options may be forestalling the eventual impact of weaker end-markets.  Of course, we may also be misreading Cat Financial’s exposures and are continuing a dialogue with management.  While we will not dismiss the disconfirming evidence of favorable portfolio metrics lightly, we still expect an eventual negative impact from pending mine closures, oil & gas bankruptcies, and equipment auctions.


FLASHBACK: Sold to You, Jamie! | $JPM

Takeaway: Remember that Old Wall narrative, "Dimon must know something" when he bought 500K shares? That was amusing.

In case you missed it, shares of JPMorgan tumbled over 4% today. Below is special commentary from Hedgeye CEO Keith McCullough who issued a prescient short signal on shares of JPM in Real-Time Alerts shortly after news broke that CEO Jamie Dimon has bought 500,000 shares.

 

 

Here are the signals McCullough sent to subscribers. 

2/12/16 - Sell signal - shorting jpm

Having been The Bear on JP Morgan for all of 2016, I find this Old Wall narrative that "Dimon must know something " rather amusing. He's obviously a smart man, so you can be rest assured that if he really understands what the economic and credit risks are in the US economy, he needs to start to try to get out in front of that.

 

From a macro forecasting perspective, what does he really know though? Does he know more than the insider who sold stock at $59? Has he even read or considered the Hedgeye Macro view?

 

All I know is that interest rates are going to continue to make lower-all-time lows as long as the prevailing macro headwinds of #Deflation and #GrowthSlowing continue. I also know that is not good for bank stocks.

 

Sold to you, Jamie.

 

KM

 

2/23/16 - BUY SIGNAL - COVERING SHORT JPM

How can we not get paid on being on the right side of the Dimon trade today?

 

Down -4% on the day, this is a big alpha generator for us inasmuch our favorite S&P Sector on the short side is (Financials).

 

Book some so that you can re-short some on the next storytelling bounce. No "peddling economic fiction" here.

 

KM


Cartoon of the Day: Cliff Dive

Cartoon of the Day: Cliff Dive - lemmings cartoon 02.23.2016

 

We warned our subscribers in July about increasing stock market risks. Despite the recent selloff, we think the worst isn't over.


Attention Students...

Get The Macro Show and the Early Look now for only $29.95/month – a savings of 57% – with the Hedgeye Student Discount! In addition to those daily macro insights, you'll receive exclusive content tailor-made to augment what you learn in the classroom. Must be a current college or university student to qualify.

What Matters More? Sentiment Or Fundamentals

In this brief excerpt of The Macro Show, Hedgeye Senior Macro analyst Darius Dale and CEO Keith McCullough discuss the relationship between the economic cycle and financial markets and how the former influences our approach to the latter.


JT Taylor: Trump Boosts Republican Turnout... Key Takeaways On Ted Cruz

Takeaway: A look at Republican versus Democratic turnout. Key takeaways on Ted Cruz heading into Super Tuesday.

Below is a brief excerpt from Potomac Research Group Chief Political Strategist JT Taylor's Morning Bullets sent to institutional clients each morning. 

TURNOUT TURNABOUT:

 

JT Taylor: Trump Boosts Republican Turnout... Key Takeaways On Ted Cruz - trump clinton

 

This primary season so far has exposed a major enthusiasm gap among the two parties. Turnout for the first three Republican contests was up 22.1% over 2012, while the Democrats have seen a 22.2% decrease. The record Republican turnout is in part due to the overwhelming number of voters motivated by Donald Trump -- whether they're supporting or opposing him. Trump has energized the field and brought with him new and previously-disengaged voters.

Hillary Clinton's campaign is counting on reviving the 'Obama coalition' of young and minority voters, but only Sanders has tapped into the youth vote so far. She's adopted (finally) a lot of his campaign rhetoric and has started to place less emphasis on herself and her qualifications, and more on what she would deliver for voters.

 

We think much of the dismal Democratic turnout can be attributed to her inability to do this so far -- she'll need to recalibrate further to deny Sanders a way back into the race and to prepare for the fall... 

TRUST-TED?

 

JT Taylor: Trump Boosts Republican Turnout... Key Takeaways On Ted Cruz - ted cruz 22

 

The raison d'être of Ted Cruz's campaign is that his character and personal convictions would give him an advantage in early, evangelical-rich states such as SC, where two thirds of Republican primary voters identified as either evangelical or born-again Christians. Yet Trump and Rubio took SC by storm, carrying the evangelical vote while Cruz was left holding the bag.

 

If Cruz can't recapture this support in the Super Tuesday Bible Belt states (AL, GA, MI, OK, TN...) which have a similar proportion of evangelical votes as SC -- we see him getting boxed out of the more moderate/purple states. 


The Eerie Specter Of 2007-2008 Looms Large

Takeaway: A precarious setup for US stocks and the economy.

The Eerie Specter Of 2007-2008 Looms Large - recession cartoon 02.22.2016

 

"No market crisis is alike, but they sure do rhyme a lot," Hedgeye Senior Macro analyst Darius Dale wrote this morning.

 

#Truth

 

Dale points to the chart below showing the 2007-2008 stock market panic against the 2016 performance of the S&P 500.

 

The similarities are uncanny.

 

 

That's not all. The eerie rhyme of 2007-2008 isn't the exclusive domain of the stock market. Recent economic data continues to confirm our Macro team's dour outlook for the U.S. (the probability of an outright #Recession in Q2 or Q3 of 2016 is rising).

 

Today's Consumer Confidence reading did little to change our opinion. U.S. Consumer Confidence slowed to 92.2 after registering it's cycle high in FEB of 2015. Remember: Consumer Confidence slowing from its cycle peak = 1 of Top 3 leading indicators for US #Recession.

 

 In the video below, Hedgeye CEO Keith McCullough discusses the 3 leading indicators of a US Recession. (Note: They're all currently flashing red.)

 

 

None of this bodes well for perma-bulls. 


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