Caterpillar's Earnings Drop in 2Q

Zacks

Caterpillar Inc. (CAT) suffered yet another dismal quarter owing to reduced mining demand and more-than-anticipated decline in dealer machine inventory. The construction and mining equipment behemoth’s second quarter earnings slumped 43% to $1.45 per share and fell well short of the Zacks Consensus Estimate of $1.70.

Revenues declined 16% to $14.6 billion in the quarter, missing the Zacks Consensus Estimate of $14.9 billion. Sales volume decreased $2.545 billion, mainly due to the impact of changes in dealer new machine inventories. Dealers reduced inventories by about $1 billion in contrast to an increase of about $300 million in the prior-year quarter.

Further, a net negative impact of acquisitions and divestitures of $140 million and unfavorable currency impact of $120 million dragged down results. However, price realization was flat compared with the year-ago quarter.

Caterpillar witnessed lower sales across all regions. Asia Pacific was the biggest sufferer (down 25% year over year) due to lower Australian mining sales in the Resource Industries segment. However, the year-over-year sales increase in China was the bright spot. Sales in EAME declined 18% followed by Latin America registering a 14% fall. Sales in North America dipped 9%.

Cost of sales declined 12% to $10.8 billion in the quarter. Selling, general and administrative (SG&A) expenses decreased 6% to $1.42 billion and research and development (R&D) expenses   went down 13% to $548 million.

Adjusted operating profit was $1.88 billion, a decline of 36% from $2.9 billion in the second quarter of 2012.  The decline in operating profit was a result of lower volume, increased manufacturing costs, and unfavorable impact from acquisitions and divestitures, partially offset by decline in SG&A and R&D expenses and favorable currency impact.

Segment Results

Machinery and Power System (M&PS) revenues decreased 17% to $13.9 billion. Resource Industries’ sales plunged 34% affected by lower dealer new machine inventories. Construction Industries’ sales dipped 9% affected by lower volume mainly from changes in dealer machine inventory. Power Systems’ sales also fell 5% due to lower volume, partially offset by higher price realization.

Financial Products’ revenues increased 4% to $806 million as the positive impact of higher average earning assets and increase in Cat Insurance revenues were offset by an unfavorable impact of lower average financing rates on new and existing finance receivables and operating leases.

However, Financial Products’ profits increased to $233 million from $188 million in the first quarter of 2013. The increase was attributed to a $31 million impact from lower claims experience at Cat Insurance, offset by a $22 million unfavorable impact from currency gains and losses.

Financial Position

As of Jun 30, 2013, Caterpillar had cash and short-term investments of $6.1 billion, up from $5.49 billion as of Dec 31, 2012. Total debt-to-capital ratio improved to 69% as of Jun 30, 2013 from 70% as of Dec 31, 2012. The debt-to-capital ratio at M&PS decreased to 34.9% as of Jun 30, 2013 compared with 37.4% as of Dec 31, 2012.

Total cash flow from operating activities in the first half of 2013 was $4.6 billion compared with $2 billion in the prior-year period. Operating cash flow at M&PS increased significantly to $3.05 billion in the second quarter from $1.28 billion in the prior-year quarter. During the quarter, Caterpillar resumed its stock repurchase program and repurchased $1 billion of stock.

Fiscal 2013 Outlook

Due to continued dealer machine inventory reductions during 2013, Caterpillar has trimmed its sales outlook to a range of $56 to $58 billion from the previous $57 to $61 billion. Caterpillar expects dealers to reduce inventory by about $3.5 billion in 2013. Caterpillar now expects to earn $6.50 per share in 2013, down from the earlier projection of earnings of $7.00 per share.

Caterpillar expects overall world economic growth of over 2%, a tad lower than the 2.3% growth in 2012. U.S. economic growth is projected at 2% in 2013. China's economy is expected to improve 7.5% compared with 7.8% growth registered in 2012. Economic growth in Africa/Middle East is projected at 3.5% and for CIS at 2.5% in 2013. The Eurozone economy is expected to decline 0.5%.

Our Take

Caterpillar’s sales started its downhill journey in Dec 2012, hurt by tougher year-earlier comparisons and rising inventories of unsold equipment. Caterpillar remains affected by slowing demand and inventory correction as a result of overproduction compared to demand. Caterpillar is struggling to bring production under control.

Caterpillar’s results have borne the brunt of continued economic turmoil in Europe and its domino effect on the rest of the world. Even though Caterpillar will benefit from the recovery in the U.S. construction sector, the recent loss of sales momentum, declining backlog, negative impact of the European debt crisis remain concerns.

Peoria, IL-based Caterpillar Inc. is the manufacturer of construction and mining equipment, diesel and natural gas engines, and industrial gas turbines. The company is one of the few leading U.S. companies in an industry that competes globally from a principally domestic manufacturing base.

Caterpillar currently retains a Zacks Rank #4 (Sell). Caterpillar's peer, Astec Industries Inc. (ASTE) reported second-quarter 2013 earnings of 48 cents per share, up 17% from the year-earlier quarter, short of the Zacks Consensus Estimate of 55 cents. Its other peers, H&E Equipment Services Inc. (HEES) and The Manitowoc Company, Inc. (MTW) are yet to announce their second quarter results.

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