Caterpillar's Q3 Earnings Lag, Trims View

Caterpillar Inc.'s (CAT) poor run continued in third quarter of 2013 as well, plagued by lower mining demand. The construction and mining equipment behemoth’s third quarter earnings dropped 43% to $1.45 per share. Earnings fell well short of the Zacks Consensus Estimate of $1.68 -- a negative earnings surprise of 14%.

Revenues declined 18% to $13.4 billion in the quarter, lagging the Zacks Consensus Estimate of $14.6 billion. Year to date, revenues dipped 17% due to reduced mining sales. Sales volume decreased $2.7 billion, with changes in dealer inventories accounting for over 50% of the decline.

Moreover, dealer deliveries to end-users declined, and more so in Resource Industries. Dealers reduced inventories by about $500 million from the second quarter end and were $2.2 billion lower than 2012 end.

A net negative impact of acquisitions and divestitures of $87 million, unfavorable price realization of $57 million and unfavorable currency impact of $188 million due to a weaker Japanese yen also dragged down results.

Caterpillar witnessed lower sales across all regions. Asia Pacific was the biggest sufferer (down 32% year over year) due to lower Australian mining sales. However, the 30% year-over-year sales increase in China was the bright spot. Sales in North America and Europe, Africa, Middle East (:EAME) both declined 18% due to unfavorable changes in dealer inventories followed by Latin America registering a 12% fall.

Cost of sales improved 16% to $9.77 billion in the quarter. Selling, general and administrative (SG&A) expenses decreased 10% to $1.3 billion and research and development (R&D) expenses went down 26% to $469 million. The overall decline in manufacturing operating expenses was due to lower discretionary and program spending, temporary factory shutdowns, and layoffs as part of cost reduction measures in response to lower volumes.

Operating profit was $1.4 billion, a decline of 46% from $2.6 billion in the third quarter of 2012. The decline in operating profit was a result of lower volume, unfavorable impact from acquisitions and divestitures and price realization, partially offset by decline in manufacturing, SG&A and R&D expenses and favorable currency impact.

Segment Results

Machinery and Power System (M&PS) revenues decreased 19% to $12.7 billion. Resource Industries’ sales was the worst affected, plunging 42% owing to lower dealer new machine inventories and lower sales volume. Construction Industries’ sales dipped 7% due to unfavorable impact of currency, lower sales volume and unfavorable price realization.

Power Systems’ sales also fell 7% due to lower volume mainly for electric power, rail and petroleum applications. Machinery and Power System segment operating profit slid 49% to $1.255 billion in the quarter, dragged down by a 63% plunge in Resource Industries and a 43% dip in Construction.

Financial Products’ revenues increased 4% to $807 million. The positive impact of higher average earning assets (barring Asia/Pacific) and increase in Cat Insurance revenues in North America were somewhat offset by declines in EAME and Latin America, and unfavorable impact of lower average financing rates on new and existing finance receivables and operating leases.

Financial Products’ profits increased to $218 million from $190 million in the third quarter of 2012. The increase was attributed to higher average earning assets and a favorable impact from lower claims experience at Cat Insurance.

Financial Position

As of Sep 30, 2013, Caterpillar had cash and short-term investments of $6.3 billion, up from $5.5 billion as of Dec 31, 2012. Total debt-to-capital ratio improved to 69% as of Sep 30, 2013 from 70% as of Dec 31, 2012. The debt-to-capital ratio at M&PS decreased to 34.1% as of Sep 30, 2013 compared with 37.4% as of Dec 31, 2012.

Total cash flow from operating activities in the first nine months of 2013 was $7.6 billion compared with $3.2 billion in the prior-year period. Operating cash flow at M&PS increased significantly to $2.1 billion in the third quarter from $994 million in the prior-year quarter. During the quarter, Caterpillar repurchased $1 billion of stock.

Fiscal 2013 Outlook

Caterpillar expects sales in the fourth quarter to be slightly higher than in the third quarter. However, earnings per share are expected to be lower due to higher costs resulting from seasonal spending patterns. The company also expects another substantial decline in dealer inventories in the fourth quarter.

For fiscal 2013, Caterpillar trimmed its sales outlook to $55 billion from the previous range of $56 to $58 billion due to lower sales expectations for Resource Industries (down 40%) and Power Systems and Construction Industries (each down 5%). Caterpillar now expects to earn $5.50 per share in 2013, down from the earlier projection of earnings of $6.50 per share due to lower sales volume including an unfavorable mix of products and lower price realization.

A Sneak Peak into 2014

Caterpillar expects revenues in 2014 to be flat with 2013 or move up or down in a 5% range. Construction Industries is expected to log sales growth, Power Systems sales will be flat, while sales in Resource Industries is expected to dip.

Economic indicators suggest that growth in the United States, Europe, Japan and China in 2014 should be in line or exceed 2013 growth. Caterpillar projects world economic growth to improve from 2.1% in 2013 to about 3% in 2014. However, lingering risks and uncertainties such as U.S. fiscal, monetary policy actions and situation in Europe may hinder positives from global economic growth.

Our Take

Caterpillar’s sales started its downhill journey in Dec 2012, hurt by tougher year-on-year 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.

Caterpillar remains focused on reducing costs by shifting production between certain facilities, rationalization of its smaller facilities, workforce reductions and reductions in program spending. Caterpillar’s cash flow has remained strong despite the drop in profits and is expecting 2013 to be its second best year in history for cash flow. Strong cash flow has enabled the company to improve its balance sheet, repurchase shares and raise its dividend by 15% and also reduce its debt level.

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 third-quarter 2013 earnings of 28 cents per share, down 3.4% from the year-earlier quarter, short of the Zacks Consensus Estimate of 37 cents. Its other peers, H&E Equipment Services Inc. (HEES) and The Manitowoc Company, Inc. (MTW) are yet to announce their third quarter results.

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