Caterpillar's Pessimism Leads To Investor Optimism

BMI View: In line with our assessment that Caterpillar has adjusted its strategy and expectations to meet the market outlook, the company delivered earnings broadly in line with guidance and above analyst estimates for Q4 2013 and FY2013. The news drove a 6% increase in the company's share price on January 27, supporting our outlook that the worst is behind the company, and longer term gains are on the horizon.

Caterpillar reported revenues of US$55.656bn in its 2013 results, a decline of 16% for the year as a whole. The results were in line with the company's most recent guidance of US$55bn for the year, updated in Q3 2013, following a consecutive periods of missed earnings estimates.

The announcement saw the company's share price rise 6%, to reach US$91.29, and we believe further gains are likely over the medium term. Although the company has released guidance for flat revenues in 2014 (US$56bn), we anticipate upside to this outlook; the Construction Industries and Power Systems units should perform well, although the mining division (Resource Industries), will continue to experience weakness.

Trending Higher
Caterpillar Share Price, US$

BMI View: In line with our assessment that Caterpillar has adjusted its strategy and expectations to meet the market outlook, the company delivered earnings broadly in line with guidance and above analyst estimates for Q4 2013 and FY2013. The news drove a 6% increase in the company's share price on January 27, supporting our outlook that the worst is behind the company, and longer term gains are on the horizon.

Caterpillar reported revenues of US$55.656bn in its 2013 results, a decline of 16% for the year as a whole. The results were in line with the company's most recent guidance of US$55bn for the year, updated in Q3 2013, following a consecutive periods of missed earnings estimates.

The announcement saw the company's share price rise 6%, to reach US$91.29, and we believe further gains are likely over the medium term. Although the company has released guidance for flat revenues in 2014 (US$56bn), we anticipate upside to this outlook; the Construction Industries and Power Systems units should perform well, although the mining division (Resource Industries), will continue to experience weakness.

Trending Higher
Caterpillar Share Price, US$

Weakness in the Resource Industries unit has been the dominant negative factor driving Caterpillar's performance in 2013. Revenues for the unit were down 37% to US$13.3bn for the year as a whole, a trend which is showing no sign of easing, with the unit recording a 48% drop in revenue recorded in Q4 2013 alone. This performance is in line with our view that Resource Industries would remain the weakest element of the company's business, owing to steep declines in mining company capital expenditure off the back of weaker commodity prices, a trend we expect to continue into 2014. Conversely, we hold an increasingly positive outlook for the Construction Industries unit, a view supported by the 20% gain revenues in Q4 2013 - the first time the unit has posted revenue growth since Q3 2012. At the same time, the Power Systems unit, also saw a positive revenue trend, posting 5% gains in Q413, versus a 4.6% decline for the year overall. We expect this trend to gain further traction in 2014, and anticipate both units will be a net positive for the company's top line.

Bright Spots Between The Lines
Revenues By Region And Segment, % Change Q4 2013 Versus Q4 2012

Change In Rhetoric Drives Confidence

The Q4 and FY2013 results release cements a key adjustment in Caterpillar's corporate strategy, first mooted in Q3 2013, which should see the company better equipped to manage current market conditions and, equally important, manage investor expectations. Our view on the company's Q3 2013 results release was that Caterpillar's language and guidance had finally moved in line with our more bearish outlook of the global economy, and the markets in which Caterpillar operates - in particular, our long held view that mining capital expenditure would suffer in 2013, hitting demand for machinery and equipment. The proof of this strategy shift is the positive investor response to Caterpillar's Q4 2013 and FY2013 results, where, despite reporting revenue declines of 10% for the quarter and 16% for the year, the share price rallied.

Caterpillar Q4 2013 And FY 2013 Financial Results, US$mn (unless otherwise stated)
Q4 2012 Q4 2013 % Change FY 2012 FY 2013 % Change
Machinery and Power Systems Sales 15,357 13,646 -11 63,068 52,694 -16
of which -
Power Systems 5,307 5,565 5 21,122 20,155 -5
Construction Industries 4,028 4,851 20 19,334 18,445 -5
Resource Industries 5,776 3,019 -48 21,158 13,270 -37
Financial Products Revenues 718 756 5 2,807 2962 6
Total Sales And Revenues 16,075 14,402 -10 65,875 55,656 -16
Profit 697 1,003 44 5,681 3,789 -33
Source: Caterpillar

Broadly speaking, we believe Caterpillar is far better prepared for 2014 than it was for 2013. Overly optimistic expectations for commodity prices and economic growth, led us to raise concerns in early 2013, especially surrounding the company's performance in the mining segment:

"Our overall outlook for the global mining sector is less optimistic than Caterpillar's. Where the company is betting on an increase in industrial metals prices in 2013, we expect prices to average lower. This is based primarily on our below-consensus outlook for Chinese growth and thus demand, impacting mining activity globally. This, combined with high costs on mining projects and increased environmental and political risk, is guiding our expectation for weaker mining activity going forward."(see, 'Caterpillar In For A Tumultuous Year', February 26 2013).

Even mid-way through the year, we were concerned that the outlook remained too bullish given the operating climate, writing in August 2013:

"The company's initial forecast for 2013 (sales between US$60bn and US$68bn; profit per share at US$7-9) seems misguided given the first half results. The company has since revised down its outlook, and is now targeting full year sales of US$56-58bn, and profit per share of US$6.50. Even with this lower guidance, we believe the company will perform toward the lower end of this scale, and that there is potential for further downgrades over the remainder of the year." (see, 'Continued Weakness Ahead As Caterpillar Adjusts To New Status Quo', August 1 2013)

However, the company's 2014 projections now align closely with our outlook for the global economy and the construction, mining and power industries. Indeed, Caterpillar's economic growth expectations are broadly in line with our own ( see below), whilst their expectation for an improvement in the construction sector aligns with our outlook for global real construction industry value growth of 3.3% (versus 2.3% in 2013).

In Line With BMI Global Assumptions
BMI Versus Caterpillar, 2014 GDP Growth Forecasts, %

Construction To Drive Recovery, But Risks Remain

Overall, the company should benefit from a continued expansion in construction activity in the US and Asia, whilst we anticipate that Europe is finally turning a corner, which bodes well for an area which has performed particularly poorly over recent years and presents opportunity for value growth. Indeed, with the European construction industry having experienced sustained weakness for several years, investment into new equipment will likely be necessary when companies become convinced of a sustained recovery.

Growth Picking Up
Regional Construction Industry Value, Real Growth, % y-o-y

However, whilst we envisage a longer term improvement in the company's performance, there remain risks on the horizon:

  • Mining Sector Weakness: This segment poses the biggest downside risk to the company's 2014 performance. We do not expect capital expenditure (capex) for mining companies to recover in the near term, with estimates for 2014 and 2015 capex showing further weakness ahead. These cuts are expected to hit new projects especially hard, therefore constricting demand for new mining equipment. However, following a US$2.9bn inventory reduction programme over the course of 2013, dealer supply and end-user demand are far better aligned going into 2014.

Further Difficulties Ahead
Select Mining Companies - Consensus Estimates for Capital Expenditure (% chg y-o-y)
  • Currency Risk: We also caution that currency fluctuations will continue to be a concern. The company registered a US$174mn negative currency impact in 2013, owing primarily to a weaker Japanese Yen. Our country risk team anticipates further weakness for the Japanese Yen over 2014, which could cause further pain, whilst our expectation for dollar strength in 2014 could see broader negative currency impacts.

  • Weaker Pricing Power: Competitive pricing was commonly cited in the company's results announcement as offsetting gains demand gains, and this issue has the potential to continue to hurt sales value in 2014. Whilst demand may be accelerating, it remains someway below previous levels, which will limit pricing power of construction equipment suppliers.

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This article is tagged to:
Sector: Mining, Infrastructure
Geography: Global, Latin America, Argentina, Brazil, Chile, Colombia, Mexico, Peru
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