Can Caterpillar Overcome the Weakness in Its End-Markets?

Caterpillar (CAT) is trading close to its 52-week lows as the stock has borne the brunt of weak oil prices. So far this year, Caterpillar is down over 20%, which is not surprising as its financial performance has been way below the mark. For instance, in the last reported quarter, Caterpillar's revenue fell 13% year-over-year to $12.3 billion, while earnings adjusted for one-time items came in at $1.27 per share as compared to EPS of $1.69 in the same period last year.

Analysts, on the other hand, were expecting EPS of $1.27 on revenue of $11.63 billion.

Though Caterpillar had performed better than expectations, it reported sales decline in all the regions it operates in, especially in Latin America.

The problem

The company is bearing the brunt of weak construction activity in Brazil and Asia, followed by an unfavorable impact of a strong dollar. Apart from this, weakness in mining and the oil and gas industries is also a big factor contributing to the soft sales numbers. In fact, management cites that it does not see any expansion in the mining sector in the foreseeable future.

To cope with these headwinds, Caterpillar has decided to streamline its operations and cut costs. Since 2012, Caterpillar has cut 20,000 full time employees globally, and management has hinted that the number could increase further in the current fiscal year. As a result of these initiatives, the company has lowered its revenue outlook for the year by $1 billion. This might be a positive step for the long run as it will help Caterpillar sustain its balance sheet during this period of lull and help it make a recovery once the fundamentals improve.

But, despite these reductions, the company intends to repurchase another $1.5 billion of stock in the third quarter, which is a plus for investors. Moreover, it has also increased its quarterly dividend from $0.70 to $0.77 in the last reported quarter. Thus, it is mindful of investors' interest and is taking initiatives to protect them.

Another look at the headwinds

Caterpillar's key segments are oil & gas, mining, and construction. But, none of these segments are in good shape. Caterpillar has a significant share of revenue coming from the Asia Pacific and the Latin America regions, which declined 21% and 25%, respectively, last quarter. This is a matter of serious concern for the company since the property market is slowing down considerably in China. A similar headwind is observed across Latin America as well.

Talking about mining, companies have significantly reduced their mining operations lately on account of weak commodity prices. As a result, Caterpillar machinery is lying unused at several of its customer sites. Moreover, as per USA Today, CEO Doug Oberhelman said:

"Prices for commodities like coal, iron ore and oil are not signaling an improvement in the short term. We are committed to controlling costs as we manage through this downturn, and that will position Caterpillar for better results when conditions improve."

However, management has provided a gloomy outlook for the short run. For the second half of the year, Caterpillar expects a negative sales mix on account of weakness in the oil and gas sector, which will consequently reduce the need for its equipment.

Conclusion

Finally, Caterpillar's financial ratios also spell trouble with a forward P/E of 16.11 as compared to a trailing P/E of 12.52, indicating weakness in its earnings growth. Analysts anticipate a drop of 7.7% in its earnings in the coming fiscal year, and the valuation indicates the same. Therefore, in light of the facts presented above, it seems prudent for investors to avoid this stock as it may slide further.
Published on Aug 27, 2015
By Harsh Singh Chauhan

Copyrighted 2016. Content published with author's permission.

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