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Why Is Caterpillar (CAT) Down 12.5% Since Last Earnings Report?

Zacks Equity Research

A month has gone by since the last earnings report for Caterpillar (CAT). Shares have lost about 12.5% in that time frame, underperforming the S&P 500.

Will the recent negative trend continue leading up to its next earnings release, or is Caterpillar due for a breakout? Before we dive into how investors and analysts have reacted as of late, let's take a quick look at its most recent earnings report in order to get a better handle on the important drivers.

Caterpillar Q2 Earnings & Revenues Miss Estimates

Caterpillar reported second-quarter 2019 adjusted earnings per share of $2.83 lagging the Zacks Consensus Estimate of $3.12. The figure also declined 5% from the prior-year quarter’s adjusted earnings per share of $2.97. Higher manufacturing costs, lower construction equipment sales in Asia-Pacific primarily dragged down by China and weak sales at the company’s energy and transportation segment weighed on the results. Following the weaker-than-expected results, Caterpillar’s shares fell 5% in pre-market trading.
 
Including one-time items, Caterpillar’s earnings per share came in at $2.82 in the prior-year quarter while there were no such adjustments in the current reported quarter.

Revenues Lag Estimates

Revenues improved 3% year over year to $14.4 billion in the quarter under review, missing the Zacks Consensus Estimate of $14.5 billion. Improved price realization and higher sales volume aided by enhanced demand for equipment were partially offset by unfavorable currency impacts. Sales increased 12% and 9% in North America and Latin America, respectively. Meanwhile, Asia Pacific and EAME witnessed decline of 8% and 6%, respectively.

Higher Manufacturing Costs Dent Profits

In second-quarter 2019, cost of sales increased 5.5% year over year to $9.9 billion on higher manufacturing costs owing to higher variable labor and burden, and warranty expenses and higher material costs, including tariffs. Gross profit dropped 2.1% to $4.49 billion on higher manufacturing costs.

Selling, general and administrative (SG&A) expenses decreased 9.1% to $1.3 billion. Research and development (R&D) expenses went down 4.5% from the prior-year quarter figure of $462 million. Operating profit in the quarter was $2.21 billion, up 2% from the prior-year quarter.  Benefits from favorable price realization and lower SG&A and R&D expense were offset by higher manufacturing costs and unfavorable sales volume owing to product mix. Operating margin was 15.3% in the reported quarter, compared with 15.5% for the second quarter of 2018.

Resource Industries & Construction Deliver Growth

Machinery and Energy & Transportation (ME&T) sales rose 3% year over year to $13.7 billion. Construction Industries sales rose 5% year over year to a record $6.5 billion mainly driven by a rise of 28% in revenues in North America due to higher demand, including the favorable impact of dealer inventories, and favorable price realization. Sales in Latin America remained flat while EAME and Asia Pacific reported declines.

Sales at Resource Industries improved 11% year over year to $2.8 billion aided by higher equipment demand and favorable price realization. Sales of Energy & Transportation dropped 4% year over year to $5.5 billion due to lower sales volume and unfavorable currency impacts.

The ME&T segment delivered operating profit of $2.18 billion, an improvement of 2% from the year-ago quarter. The Resource Industries reported operating profit of $481 million in the second quarter, up 17% from the prior-year quarter thanks to higher sales volume and favorable price realization. However, higher manufacturing costs somewhat negated these benefits. Construction Industries’ profit improved 8% to a record $1,247 million due to favorable price realization partially offset by higher manufacturing costs. At the Energy & Transportation segment, operating profit declined 12% to $886 million on account of an unfavorable mix of applications and lower volume.

Financial Products’ revenues went up 5% to $873 million. Financial Products' profits were $193 million in the reported quarter, up 44% from $134 million in the prior-year quarter.
 
Strong Cash Position

Caterpillar ended second quarter-2019 with cash and short-term investments of $7.4 billion, down from $7.9 billion at 2018 end. In the reported quarter, ME&T operating cash flow was $2 billion. During the second quarter of 2019, the company repurchased $1.4 billion of its common stock and paid out dividends worth $0.5 billion.

Backlog Declines

At the end of the second quarter of 2019, Caterpillar’s backlog was at $15 billion, a sequential drop of $1.9 billion.

Guidance

For 2019, Caterpillar maintains adjusted earnings per share guidance of $11.75-$12.75. Including a 31 cents per share discrete tax benefit related to U.S. tax reform, the guidance is at $12.06-$13.06. The company currently expects to be at the lower end of this outlook range. Caterpillar expects modest sales growth in 2019, which assumes a recovery in Oil and Gas near the end of the year and dealers working through higher machine inventory levels. Price realization will help mitigate manufacturing costs. With a higher amount of restructuring costs incurred in the second quarter of 2019, Caterpillar anticipates restructuring costs for the remainder of the year to be significantly lower.

How Have Estimates Been Moving Since Then?

It turns out, estimates revision have trended downward during the past month. The consensus estimate has shifted -6.13% due to these changes.

VGM Scores

Currently, Caterpillar has a nice Growth Score of B, though it is lagging a lot on the Momentum Score front with a D. However, the stock was allocated a grade of A on the value side, putting it in the top 20% for this investment strategy.

Overall, the stock has an aggregate VGM Score of B. If you aren't focused on one strategy, this score is the one you should be interested in.

Outlook

Estimates have been broadly trending downward for the stock, and the magnitude of these revisions indicates a downward shift. Notably, Caterpillar has a Zacks Rank #3 (Hold). We expect an in-line return from the stock in the next few months.



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