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Improving Demand to Drive Caterpillar Despite Higher Costs

Zacks Equity Research

On Jan 4, we issued an updated research report on Caterpillar Inc. CAT. Backed by its cost-saving efforts, and favorable commodity prices and end markets, the company seems poised for improved results. However, raw material cost inflation, higher transportation costs and supply chain challenges remain as the primary hurdles for the mining and construction equipment behemoth. 


Upbeat Fiscal 2018 Expectations Despite Higher Costs


Caterpillar’s third-quarter 2018 marked the company’s seventh consecutive quarter of both top and bottom-line growth, after a string of dismal performances for four years. This was aided by improved end-user demand across all regions and most end markets. Further, the backlog was at $17.3 billion at the quarter end, an improvement of $12.9 billion year over year aided by increase at all segments.


However, material cost inflation will affect Caterpillar’s margins. For fiscal 2018, the company anticipates the impact of recently imposed tariffs to be at the low end of its previous expected range of $100-$200 million. Further, the company has been bearing the brunt of supply chain challenges and higher freight rates.


Nevertheless, backed by strong order rates, increasing backlog bode and improved markets, Caterpillar guides earnings per share between $11.00 and $12.00 for fiscal 2018. The mid-point of the range reflects a year-over-year rise of 67%. The Zacks Consensus Estimate for fiscal 2018 is currently pegged at $11.64, reflecting year-over-year growth of 69%.


Restructuring, Expanded Offerings to Aid Performance


In September 2015, Caterpillar initiated significant restructuring and cost reduction initiative which is expected to lower annual operating costs by about $1.5 billion. This includes the consolidation or closure of more than 30 facilities and reduction of workforce by more than 16,000. This will boost margins in the future.


Meanwhile, Caterpillar continues to focus on customers and on the future by continuing to invest in digital capabilities like e-commerce, connecting assets and jobsites along with developing the next generation of more productive and efficient products. The company is readying factories and suppliers to meet increased demand, while remaining focused on developing a more competitive and flexible cost structure. This should enable it to respond quickly if economic fundamentals change.


Segments Poised for Growth


The Construction Industries in North America are likely to benefit from continued improvement in residential and non-residential construction, and revival in infrastructure demand. Infrastructure development in China will also be a catalyst. EAME is anticipated to continue growing amid high business confidence and stability in oil-producing countries. Due to increasing commodity prices, miners are resuming capital spending which bodes well for the Resource Industries segment.


Sales into Oil and Gas applications are projected to increase aided by stable oil prices. Sales for industrial applications will remain robust, primarily backed by improving global economic conditions and higher end-user demand across most applications. Sales to the Transportation sector will gain primarily from recent acquisitions in rail services. The North American rail market is also showing signs of recovery. There has been a noted increase in activity for new locomotives. Demand increases for rail services and locomotive rebuilds have also been witnessed. Power Generation sales are improving after a multi-year downturn.


Recent Slowdown in Retail Sales Growth a Woe


Caterpillar reported an increase of 16% in global retail sales for the three months ended November 2018, down from a rise of 18% witnessed in October. This was the lowest in 2018. Despite this recent drop, Caterpillar reported average sales growth of 25% in the first 11 months of 2018, an improvement from the 8% average in the comparable period last year. Also, Resource Industries, Construction Industries and Energy & Transportation continued to report positive gains for the 17th, 22nd and 15th consecutive months, respectively. 


Price Performance



Caterpillar’s shares have dipped 23% over the past year, while the industry registered a decline of 28%.


Zacks Rank & Stocks to Consider


Caterpillar currently carries a Zacks Rank #3 (Hold).


A few better-ranked stocks in the same sector are Brady Corporation BRC, Lindsay Corporation LNN and Heritage-Crystal Clean, Inc. HCCI. All three stocks carry a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.


Brady has a long-term earnings growth rate of 7.5%. The company’s shares have gained 15% over the past year.


Lindsay has an estimated long-term growth rate of 18%. Its shares have gained 7% in a year’s time.


Heritage-Crystal Clean has a projected long-term growth rate of 15%. Its shares have gained 7% over the past year.


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