Caterpillar Inc. (CAT) Q3 2013 Earnings Conference Call October 23, 2013 11:00 AM ET
Mike DeWalt – Vice President of Caterpillar Inc. with responsibility for the Strategic Services Division
Douglas R. Oberhelman – Chairman and Chief Executive Officer
Bradley M. Halverson – Group President and Chief Financial Officer
Jerry D. Revich – Goldman Sachs & Co.
Ted Grace – Susquehanna Financial Group LLP
David Raso – ISI Group
Eli S. Lustgarten – Longbow Securities
Stephen Volkmann – Jefferies & Company
Seth R. Weber – RBC Capital Markets, LLC
Andrew Casey – Wells Fargo Securities
Robert Wertheimer – Vertical Research Partners, LLC
Andrew Kaplowitz – Barclays Capital, Inc.
Ann P. Duignan – JPMorgan Securities, LLC
Good morning, ladies and gentlemen, and welcome to the Caterpillar Third Quarter 2013 Earnings Results. 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, Kate, and good morning, everyone, and welcome to our 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.
Today’s call is copyrighted by Caterpillar Inc., and 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 sections of our Caterpillar.com website, and it will be 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 that’s Risk Factors of our Form 10-K filed with the SEC in February of this year, and also in today’s forward-looking statements language.
We’ll start this morning with a review of the quarter, our outlook for 2013, and a preliminary look at our sales and revenues for 2014. For the third quarter, sales and revenues were $13.4 billion, and that’s a $3 billion, or 21% decline from the third quarter of 2012. The decline was principally a result of change of dealer inventories and lower end-user demand.
The sales decline was mostly in our Resource Industries segment, which is principally mining, where sales were up 42% versus the third quarter of 2012. Sales in our Power Systems and Construction Industries segments were each down about 7% in the quarter and driven mostly by dealer inventory changes and in the case of construction currency impacts.
End-user demand for both Power Systems and Construction Industries were relatively flat with last year. Now, the sales in our Resource Industries segment, which is mostly mining had behaved more like Construction and Power Systems, we’d certainly be having a different and more positive discussion today. But the reverse is also true, if Construction Industries and Power Systems were seeing similar conditions as mining, it would be a much more negative story in a way that’s the silver lining in the down year like 2013.
It’s good that we have different businesses that are all behaving the same way at the same time. While Resource Industries sales are very low, sales in Power Systems, Construction Industries have been more stable. In fact, despite the drop in Resource Industries, which we expect sales to be down about 40% this year; you might be surprised that our outlook expects 2013 to be the third highest year for sales and revenues in our history.
Profit in the quarter was $1.45, and that was down $1.09 from $2.54 in the third quarter of 2012. The decline in profit is primarily a result of the $3 billion drop in sales and absence of last year’s gain on the sale of our third-party logistics business.
For the quarter, our decremental operating profit pull-through, and that’s a decline in operating profit as a percent of the decline in sales and revenues, was close to 30%, if we exclude last year’s gain from the logistics business. We think that’s pretty good, considering how much of the decline was from mining products, which have a relatively higher variable margin.
We were able to do that because of the cost actions we’ve taken this year. Being cost-flexible in a downturn is a key element of the strategy and we’re executing. Volume-adjusted costs were down over $350 million in the quarter, and excluding inventory absorption impacts, it was more like $450 million.
Year-to-date, we flexed our variable cost down with volume, and beyond that, we’ve taken out cost, again, excluding inventory absorption impacts by about $700 million, and that’s year-to-date. To achieve that, we’ve had numerous temporary plant shutdowns, a reduction of more than 13,000 of our global workforce since this time last year, we’ve had temporary layoff for thousands of salaried management employees, we’ve had reductions in program spending, substantially lower incentive pay, and we’ve implemented general austerity measures across the Company. In addition to lower cost, we’ve also cut CapEx, and through the first nine months of 2013, it’s down nearly 20%.
Now, we’ve also continued to improve operational performance throughout the Company, but unfortunately much of that improvement is being overshadowed by the decline in mining sales. We’ve improved safety in our factories, we’ve improved product quality, and we’re seeing that in the metrics that we track, and that’s what we’re hearing from dealers and customers.
For most of our major machine families and that includes mining overall, our sales of products to end customers are doing better than our machine competitors as a whole. We’ve also done a good job executing in China, and sales there are up about 20% year-to-date and almost 30% in the third quarter.
Okay, that’s a quick summary of the quarter. I’m going to move on to the outlook for 2013. This morning we lowered the outlook for sales and revenues to about $55 billion. That’s a decline of about $2 billion from the midpoint of our previous outlook.
We’re now expecting profit in 2013 to be about $5.50 a share, and that’s down from $6.50 at the middle of the previous sales outlook range. While sales in revenue expectations are lower across much of the company, the decline was most significant in mining and that’s in our Resource Industries segment.
Mining has been difficult to forecast and that’s been the case all year. And I think it’s worth recapping what happens to the outlook over the course of 2013. And that story starts about mid-2012, when orders of new mining equipment began to drop substantially and they remained low through the remainder of 2012.
By the time we got to the outlook that we provided in January of 2013, we’ve been seeing few mining orders and we understood from customers that they intended to reduce CapEx, because of that our outlook from last January included a drop in mining sales for 2013.
Now that said, we were still seeing strong mining production levels from most commodities and we were expecting that mining companies will start ordering more as 2013 progress. Now to be clear, we were not expecting at that time a quick return to the higher order rates of early 2012, but we did expect some improvement later in 2013.
By the time of our April outlook, orders had still not improved much, so we lowered expectations in our outlook for mining. We’ve reduced the sales and revenues outlook again when we released our second quarter results in July and that brings us to today. We’re still seeing strong mine production. In fact, some of the big mining companies are setting production records. But despite that, we’re still not receiving nearly as many orders as we expected and our outlook today is lowered as a result.
With the outlook now is $55 billion, we expect the full year to be down almost $11 billion from 2012, and about $8 billion of that is Resource Industries. In terms of profit, we’ve reduced our outlook for 2013 by $1 a share. The most significant for the reason for the lower profit is sales volume.
Price realization, currency impacts, product mix and cost absorption from lower inventory are also contributing. We did have a favorable tax item in the third quarter and that’s helped to offset some of the profit declines. With one quarter to go, our full-year outlook for 2013 is essentially an outlook for the fourth quarter.
If you subtract nine months of actual from the full-year outlook, you’ll see that we’re expecting sales and revenues in the fourth quarter to be a few $100 million higher than the third quarter, but profit per share to be about 16% lower than the third quarter. The $0.16 profit drop is from the absence of the favorable tax item in the third quarter and higher costs in the fourth quarter. And that’s common in Caterpillar that costs are up in the fourth quarter. It’s usually a high seasonal quarter for us and the first quarter is usually the low seasonal quarter.
Okay, that’s the outlook for 2013. Let’s turn to 2014, and we’ll start with economics. In general, we think 2014 could be a better year for global growth. However, we are concerned. We’ve been in a similar position over the past two years. When economic indicators began to look more positive, we forecast better global growth, that drove the expectations around key industries that are important to our business and we set our outlook. As it turned out, world economic growth was weaker than we expected.
Today, while it looks like there is a good chance that the world economy could improve next year, there is still much risk and uncertainty. The direction of U.S. fiscal and monetary policy remains uncertain and the climate in Washington is divisive. Eurozone economies are far from healthy and China continues to transition for a more consumer-demand led economy. In addition, despite higher mine production around the world, new orders for mining equipment have remained low.
As a result, we’re holding our preliminary outlook for 2014 sales and revenues flat with 2013 in a plus or minus 5% range. We’re expecting some growth in Construction Industries relatively flat sales in Power Systems and a decline in Resource Industries. Within the decline in Resource Industries, mining remains very cloudy and tough to forecast. The $8 billion decline that we’ve seen in 2013 has been largely from equipment sales. And that decline in equipment sales has been split between lower end-user demand and the impact of dealer inventory.
Embedded in our outlook for down sales for Resource Industries in 2014 is more decline in end-user demand for mining equipment. Our outlook for 2014 in fact includes a greater percentage decline in end-user demand in 2014, than we’ve had so far in 2013. However, that’s partially offset by the impact of dealer inventory changes.
Dealers have reduced mining inventory substantially in 2013. That means what we’ve sold to dealers this year is much less than what end customers have been buying from them. For 2014, we’re not expecting nearly the scale of dealer inventory reduction that we’ve seen this year, and that should help offset some of the decline in end-user demand.
Mining orders have been weak since the middle of 2012, and we’d like to start seeing some uptick. We all know this is an industry that has a history of quickly and significantly changing course, both up and down, and we’ve seen it move dramatically in both directions over the past five years.
That said, and despite prospects for improved economic growth in 2014 and the continuation of strong mine production around the world, we won’t be increasing our expectations for Resources Industries until mining orders improve.
Now, one thing you won’t find in today’s release around our 2014 outlook is a profit expectation, and that’s normal for us. At this time of the year, we commonly provide a sales outlook which we’ve done but not profit, and that’s because we’re still working our plans for next year. It’s our usual practice to provide our first profit outlook with our year-end release in January and we certainly expect to do that.
I’d like to finish today with a few comments on cash flow and the balance sheet, and then we can move on to the Q&A. Although it has been a challenging year for sales and profit, it had been a very good year for cash flow. In the third quarter, Machinery and Power System operating cash flow was $2.1 billion, and even if we stop today at the end of the third quarter, the nine-month mark for the year, those nine months would be our second best year for cash flow in history. And that’s enabled us to continue improving our balance sheet, in fact our Machinery and Power Systems debt-to-capital ratio currently stands at about 34% and we expect this kind of improve again in the fourth quarter.
We’ve also returned cash to shareholders. We’ve repurchased $2 billion of CAT stock this year and we’ve raised the quarterly dividend by 15%. We had $1.7 billion remaining on our Board authorization to repurchase stock and that expires at the end of 2012. We’re not announcing additional stock repurchase today, but our priorities for the use of cash are unchanged. There are certainly many factors that could impact the future, but the strength of our balance sheet and cash flow are positive indicators of our potential to complete the authorization before it expires.
Okay, with that let’s move to the Q&A.
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