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Caterpillar Inc. (CAT - Analyst Report) topped Dow Jones last week with a gain of 8.98% while major components like Amazon.com Inc. (AMZN - Analyst Report), Chevron Corp. (CVX - Analyst Report) and Wal-Mart Stores Inc. (WMT - Analyst Report) suffered declines on disappointing earnings and weakened forecasts. The index had an unfortunate week losing 1.1% over the five days of trade.

It was an eventful and positive week for the mining machinery giant starting with a 6% increase in its share price on Monday, Jan 27 on the back of a fourth quarter earnings beat. The share price further found support as news of renewed investments in Northern Ireland and share repurchases came in. Caterpillar shares closed at $93.91 on Friday after touching a high of $94.69 during intraday trading.

It has almost been a year since the company hit the $90+ mark. Such elevated share prices were last seen in Feb 2013. Caterpillar came across a rough patch for most of last year with struggling growth rates. Though the turnaround in Caterpillar shares is encouraging, it remains to be seen whether the company can sustain this momentum, improving upon its previous 52-week high of $99.10 attained on Feb 5, 2013.

Factors Leading to the Turnaround

Rise in Q4 Earnings after 3 Quarters of Decline

Despite reporting a 10% decline in its fourth quarter sales to $14.4 billion, Caterpillar delivered a 48% rise in its earnings to $1.54 per share. The final quarter of the year broke the jinx of negative earnings surprises – four in a row – and also marked the first year-over-year earnings improvement in 2013. 

In spite of challenging macroeconomic conditions and reduced demand for its mining equipment, cost reduction was the key to Caterpillar’s success in Q4. Earnings in the first three quarters of 2013 were plagued by lower mining demand.

Performance Betters the Peer

Caterpillar’s earnings beat was made sweeter by Joy Global Inc.’s (JOY - Analyst Report) debacle in the reported quarter. Joy Global’s adjusted earnings of $1.11 per share plummeted 47% from the year-ago figure of $2.10 per share. Earnings however came in line with the Zacks Consensus Estimate. Depleting backlogs and a decline in orders pulled back results.

Caterpillar Committed to Boost Shareholder Returns

Despite a tumultuous year, Caterpillar continued to deliver strong cash flow and reward shareholders. The company ended 2013 with cash and short-term investments of $6.1 billion, up from $5.5 billion at 2012 end.

The debt-to-capital ratio at Machinery and Power System (M&PS) improved substantially to 29.7% as of Dec 31, 2013, compared with 37.4% as of Dec 31, 2012. This was the lowest debt-to-capital ratio in over 25 years. Operating cash flow at M&PS was a record $9 billion in 2013, up from $4.2 billion in 2012, thanks to the $2.9 billion inventory reduction during the year.

On Thursday, the company announced its intention to purchase approximately $1.7 billion of its common stock under an accelerated stock repurchase transaction. With this the company will complete its previous $7.5 billion repurchase authorization.   

Caterpillar’s board of directors had authorized the repurchase of $7.5 billion of its common stock in Feb 2007. Until 2008, Caterpillar had spent $3.8 billion of the authorization and no shares were repurchased since then. In Dec 2011 this program was extended through Dec 2015. Following its first-quarter 2013 earnings, Caterpillar decided to resume the program, given its balance sheet strength and positive cash flow.

Subsequently, Caterpillar repurchased $2 billion of common stock in the balance of 2013. At the fourth quarter conference call, the company announced that its board of directors approved a fresh $10 billion stock repurchase program that will expire on Dec 31, 2018.

If that was not heartening enough, Caterpillar hiked its quarterly dividend by 15% to 60 cents per share in 2013, marking the highest percentage increase in dividend since the financial crisis of 2008. These repurchases and dividend hikes affirm its commitment to deliver superior returns to its shareholders.

Investments Resumed

Last week, Caterpillar also divulged its plans to invest $9 million (£5.4m) to expand its truck parts manufacturing operation in Northern Ireland. This will help generate up to 100 jobs at its plant in Larne, County Antrim. In Sep 2012, Caterpillar’s decision to shift production of a line of diesel generators from its FG Wilson subsidiary, from Northern Ireland to China, had cost 760 jobs. A slowdown in global demand for Caterpillar’s generator sets led to the job cuts.

Given the slowdown in demand, the mining and equipment behemoth had reined in its investment and acquisition activities in 2013. If the current investment in Ireland is any sign, Caterpillar might well loosen its purse strings going forward, encouraged by a recovering world economy.

A Brighter 2014

Caterpillar expects revenues in 2014 to be flat with 2013 levels, up or down 5%. Excluding restructuring costs, earnings per share are expected at $5.85. Construction Industries and Power Systems are expected to deliver sales growth on the heels of better economic growth. However, sales in Resource Industries will continue to be challenging, as mining companies keep cutting their pockets with lower capital expenditures for 2014.

Caterpillar was hurt by slowing demand and inventory correction as a result of overproduction compared to demand in 2013. While these inventory reductions were a significant sales and production headwind in 2013, their impact on the company’s sales is now largely over.

The company might finally be seeing light at the end a dark tunnel. It is all set to reap the benefits of its cost reduction activities, namely, shifting production between certain facilities, rationalization of its smaller facilities and workforce reductions. Also, improving economic conditions, especially in China, and recovery in the construction sector could be catalysts for Caterpillar.

Peoria, IL-based Caterpillar Inc. is the manufacturer of construction and mining equipment, diesel and natural gas engines, and industrial gas turbines. The company is one of the few leading U.S. companies in an industry that competes globally from a principally domestic manufacturing base. Caterpillar currently retains a Zacks Rank #3 (Hold).

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