Caterpillar (CAT) Q4 2013 Earnings Conference Call January 27, 2014 11:00 AM ET
Mike DeWalt – VP, Strategic Services Division
Douglas Oberhelman – Chairman and CEO
Bradley Halverson – Group President and CFO
Andrew Kaplowitz - Barclays
Ross Gilardi - Bank of America
Jamie Cook - Credit Suisse
David Raso - ISI Group
Nicole DeBlase - Morgan Stanley
Alex Potter - Piper Jaffray
Robert Wertheimer - Vertical Research Partners
Good morning, ladies and gentlemen, and welcome to the Caterpillar full year and Q4 2013 results conference call. At this time, all lines have been placed on a listen-only mode, and we will open the floor for your questions and comments following the presentation. It is now my pleasure to turn the floor over to your host, Mr. Mike DeWalt. Sir, the floor is yours.
Thank you very much, and good morning everyone, and welcome to our year-end earnings call. This is Mike DeWalt, Caterpillar’s vice president of strategic services. On the call today, I’m pleased to have our chairman and CEO, Doug Oberhelman; and group president and CFO, Brad Halverson.
This call is copyrighted by Caterpillar Inc. Any use, recording, or transmission of any portion of the call without the expressed written consent of Caterpillar is strictly prohibited. If you would like a copy of today’s call transcript, we’ll be posting it in the Investor section of our Caterpillar.com website, in the section labeled Results Webcast.
This morning we’ll be discussing forward-looking information that involves risks, uncertainties and assumptions that could cause our actual results to differ materially from the forward-looking information. The discussion of some of the factors that individually, or in the aggregate, could make actual results differ materially from our projections can be found in our cautionary statements under Item 1-A, Risk Factors, of our Form 10-K filed with the SEC in February of 2013, and also in the forward-looking statements language continued in today’s release. Now, in addition to that, there’s a reconciliation of non-GAAP measures, and that can be found in today’s financial release, which has also been posted on our website at caterpillar.com.
Okay, let’s get started. And this morning I’ll be covering four main topics before we get to the Q&A. They’re fourth quarter financial results, a recap of 2013, the 2014 sales and profit outlook, and I’ll start this morning with the fourth topic, and that’s the $1.7 billion of stock repurchase that we’re expecting in the first quarter, and the new $10 billion stock repurchase authorization that we announced this morning.
Now, to set the stage for stock repurchase, it’s good to know that we had a great year for cash flow in 2013, and finished the year with a strong balance sheet. We set a new record for machinery and power systems operating cash flow at about $9 billion. And that was about $1 billion more than the previous record, from 2011.
We ended 2013 with a machinery and power systems debt to capital ratio of 29.7%. That’s almost 8 full percentage points below where we ended 2012 and our lowest debt to cap in more than 25 years. You have to go back to 1987 to find a lower one.
2013 was also a year where we repurchased $2 billion in Caterpillar stock and last year we raised the quarterly dividend by 15%. 2013’s cash flow and the strength of our balance sheet underpin this morning’s announcement that we expect to complete our existing stock repurchase authorization and our board’s approval for a new $10 billion program.
So, record cash flow, strong balance sheet, $2 billion of share repurchase in ’13, plus a number of $1.7 billion expected this quarter, and a new $10 billion authorization. We think that’s all great news for shareholders and a reflection of strong operational performance in 2013 and our confidence over the long term.
Let’s move on to fourth quarter results. And certainly, while 2013 was a tough year, we’re pleased to be ending it on a more positive note, with sales and revenues nearly $700 million above our outlook and profit $0.25 a share above the outlook.
For the quarter, sales and revenues were $14.4 billion, and that’s about $1.7 billion, or about 10%, below the fourth quarter of 2012, which was $16.1 billion. Profit per share was $1.54, and that’s up $0.50 a share from the fourth quarter last year.
While profit is up, we did have two large items that occurred in the fourth quarter of 2012 that had a sizable impact on profit. We had the $580 million goodwill impairment that was negative to profit, about $0.87 per share last year, but we had a $300 million favorable tax settlement in 2012, and that helped profit by $0.45 a share. So if you exclude those two large items, our quarter over quarter profit per share improvement was about $0.08.
Now, for sales, more than all the quarter over quarter sales decline was in resource industries, which is principally mining. Resource industry sales were down 48% from the fourth quarter of 2012. That substantial decline was the result of both lower demand from mining customers and from changes in dealer inventory.
While resource industry sales in the fourth quarter were well below the fourth quarter of 2012, they were about the same as the previous quarter, and that was the third quarter of 2013. Sales in each of the past two quarters have been roughly $3 billion for resource industries.
And I’ll talk about the 2014 outlook in a few minutes, but it’s worth noting at this point that the $3 billion a quarter that we’ve seen for the past couple of quarters for resource industries is about what we’re expecting to average in the outlook for 2014. Probably a little below $3 billion a quarter in the first half, and a little better in the second half.
On a much more positive note, fourth quarter sales in construction industries were up 20% from the fourth quarter of 2012. Power system sales were up 5%, and financial products revenues were up 3%. That’s great news, and that demonstrates balance in our business. While we serve a number of cyclical industries, they don’t all move the same way at the same time, and it’s great that construction and power systems were up.
Now, excluding the goodwill impairment that happened in the fourth quarter of 2012, operating profit declined about $166 million. That’s $166 million on a sales and revenues decline of about $1.7 billion, and there were certainly a number of puts and takes, but overall, we’re pleased with our operational performance and the decremental operating profit pull through of about 10% in the fourth quarter.
Manufacturing costs were favorable, $480 million versus the fourth quarter of 2012, and SG&A and R&D were favorable, combined about $200 million. Cost performance was the main driver of the good decrementals, and that was in a quarter where we didn’t get any help from price realization, which was about neutral, and our sales mix was unfavorable, because more than all of the sales decline was in resource industries and because of mining.
Bottom line for the quarter, resource industries was down, but power systems, construction, and financial products were all better than the fourth quarter of 2012.
Okay, so that’s the quarter. Let’s move on to a recap of the full year, which was a tough one, particularly for our resource industry segment. Back in January of 2013, when we started the year and provided our first outlook, the midpoint of our 2013 range expected sales and revenues to be down from 2012.
In fact, sales in 2013 were down and the decline in mining sales in our resource industry segment was much more significant than we’d expected. As a result, we ended 2013 with sales about $10 billion, or 16%, below 2012, and of that $10 billion, about $8 billion was in resource industries and about $1 billion each was in construction and power systems.
Now, as a result of that $10 billion sales decline, profit was down as well, from $8.48 a share in 2012 to $5.75 in 2013. While profit was down, our operational performance for the year was good. Our decremental operating profit pull through was less than 30% and that was despite a major headwind from product mix.
With most of the year’s sales decline coming from relatively high-margin mining products, the sales mix headwind on profit was about $750 million in 2013 versus 2012. We also had a sizable headwind from negative cost absorption, and that was related to our large inventory reduction in 2013.
We had good performance, despite those headwinds, because we took action on costs. Excluding the cost absorption impact from inventory, our manufacturing, R&D, and SG&A costs were collectively down $1.2 billion in 2013. That $1.2 billion improvement was the result of favorable material costs, lower incentive pay, short term actions that we took, like temporary plant shutdowns and rolling layoffs. And as the year progressed, we started on more structural actions.
The restructuring actions that we took in 2013 resulted in nearly 2,000 fewer management and support employees, 4,500 fewer production employees, and the closing, downsizing, or consolidation of a number of manufacturing facilities.
While those restructuring actions spanned the company, they were more concentrated in resource industries. We incurred $200 million of restructuring costs in 2013, of which about $130 million was in the fourth quarter, and we’re expecting another $400 million to $500 million in 2014.
I’ll talk a bit more about that when I cover the 2014 outlook, but before I do that, I didn’t want to end this recap of 2013 without giving a little rest of the story. While 2013 was a year overshadowed by the big drop in mining, there were a lot of good things that happened at Caterpillar.
First, while mining was negative, we’re a diverse company. We serve a wide range of industries across the globe. And while sales declined in construction and power systems, that decline was small compared with resource industries. Power systems profit was within $50 million of its 2012 record, and our financial product segment delivered record profit in 2013.
The fourth quarter of 2013 top line for construction, power systems, and financial products, and their bottom lines, were better than the fourth quarter of 2012. I mentioned it earlier, and I think it’s worth mentioning again, it was a great year for cash flow. We set a new record for machinery and power systems, operating cash flow at $9 billion. We repurchased $2 billion of Caterpillar stock in 2013, and we raised the dividend by 15%.
We ended with a strong balance sheet, with over $6 billion in cash, and the lowest debt to capital ratio in 25 years. It was also a year of inventory correction, for both us and for our dealers. We reduced our inventory almost $3 billion and dealers reduced their inventories by more than $3 billion.
They were significant sales and production headwinds in 2013, but we think the significant impact on our sales is largely over. That doesn’t mean that every quarter we’ll be exactly flat, but overall for the company, we continue to believe that inventory changes will be a big story in 2014, like it was in 2013.
In 2013, we also improved our market position for CAT machines again, and made particularly strong gains with excavators in China. And speaking of China, our total sales and revenues there in 2013 were about $3.5 billion, and that was up more than 20% from 2012.
From an operational perspective, we also continue to make improvements in safety and quality, and while we understand that quality improvement is continuous, our dealers and customers give us feedback that let us know they’re seeing results.
So, with that recap, let’s move on to the outlook. Overall, sales and revenues in 2014 are expected to be roughly similar with 2013, at about $56 billion. And that would be in a range of about plus or minus 5%.
There are encouraging signs in the world economy, and we’re seeing some in our own business, and that gives us optimism for sales in our construction and power systems segments, and we think they’ll each be up about 5% in 2014.
However, we continue to be cautious about the mining industry. Despite prospects for the improved economic climate and continued strong production at mines, we are expecting a sales decline in our resource industry segments of about 10% in 2014.
The good news is, mine production has generally been up and improved in 2013, and we think it will likely be up again in 2014. The bad news is that orders for new equipment remain pretty low. But we don’t think that can go on indefinitely, and we remain positive on our long term view of mining.
Based on the size and age of existing equipment fleets, we believe that miners are buying new equipment at a rate that’s well below the average replacement level they’ll need going forward. As an example, we think that our sales of large mining trucks in 2014 will be around half the long term replacement level. That should be a positive for sales in the future.
In 2013, we took substantial actions to reduce cost, and we’re expecting to take more in 2014. That means that we’re expecting additional restructuring actions and charges in 2014 of $400 to $500 million, and that’s in addition to the $200 million of restructuring costs that we had in 2013.
The most significant item in 2014 is the restructuring of our Gosselies, Belgium facility. We announced that program on December 23 of 2013, and it’s designed to improve the competitiveness of our European manufacturing footprint by refocusing our current Gosselies operations on final machine assembly, test, and paint, with limited component and fabrication operations.
The actions there will include reshaping the supply base for more efficient sourcing, improving factory efficiencies, and workforce reductions. Our proposals are subject to Belgian ministerial approval, and we think a decision by the Belgian minister of employment will occur in the first quarter of 2014. And, subject to that approval, we expect to recognize about $300 million of employee related separation charges throughout 2014.
The remaining restructuring costs of $100 million to $200 million that are anticipated in our outlook are related to a wide range of actions across the company, and a part of our ongoing efforts to optimize our cost structure and improve the efficiency of our operations.
While we’re expecting numerous actions, we don’t expect that individually the charges would be significant. We expect that the restructuring actions taken in ’13 and that we’re anticipating for ’14 will be about $200 million favorable to our ongoing costs in 2014 and $400 million to $500 million per year favorable to ongoing cost after 2015.
Now, the most significant reason the 2014 impact is lower than the impact after 2015 is the timeframe involved in implementing the program in Gosselies, Belgium. It’s extensive, and it will take several years to complete. In addition, the other actions that we’re expecting to take in 2014 will occur over the course of the year, and as a result, we’re expecting partial year benefits in 2014.
In total, we estimate the after-tax impact of the restructuring charges in 2014 to be between $0.50 and $0.60 a share. Our profit outlook for 2014 is $5.85 a share, at $56 billion of sales and revenues, excluding the $0.55 midpoint of the restructuring charges and about $5.40 per share, all in, including the restructuring.
Now, there are a number of reasonably important moving pieces that are factored into our 2014 outlook, and we’ve provided a listing of those key items in the profit outlook section of this morning’s financial release. And if you haven’t already, I would encourage you to read through that.
So, in summary, on the outlook, $56 billion of sales and revenues in 2014. That’s relatively flat with ’13, in a range of plus or minus 5%, and $5.85 a share without restructuring, $5.30 all in.
One last point on the outlook, and that’s around the first quarter. For the full year, our sales and revenues outlook expects roughly flat sales. And sales flat with the first quarter of 2013 is probably a reasonable ballpark for you to think about for Q1 2014.
However, as you think about first quarter profit, you may be looking back to the first quarter of 2013 as a reference point. And if you do, there’s one fairly significant item you need to consider, and that’s that last year, we had an $87 million favorable tax item in the first quarter, and that was related to the research and development tax credit that was retroactively extended in 2013 for 2012. And that certainly won’t be in the first quarter of 2014.
So, that’s the outlook, and we’re ready to move on to the Q&A portion of the call.
Earnings Call Part 2: