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Caterpillar (CAT) to Gain From Cost Cuts Amid Weak Demand

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On Sep 24, we issued an updated research report on Caterpillar Inc. (CAT - Free Report) . The company’s results have been bearing the brunt of low demand this year amid the global economic uncertainty stemming from the coronavirus pandemic as well as the weakness in the manufacturing sector. However, recent data indicates that the manufacturing sector seems to be coming out of the woods — which will be a positive for Caterpillar. The company will also gain from its efforts to control costs and proactively manage production. Strong liquidity position, investments in expanded offerings and services, and digital initiatives, including e-commerce, will also fuel growth.

Weak Demand Amid COVID-19

Due to lower demand across all segments and geographies, mainly affected by the COVID-19 pandemic, the construction and mining equipment behemoth reported a plunge of 46% in first-quarter 2020 earnings followed by a slump of 64% in the second quarter. At the end of the second quarter, Caterpillar’s order backlog was $12.9 billion, down $1.2 billion from the first quarter. Moreover, Caterpillar’s global retail sales have been declining for straight nine months now. The company’s global retail sales recorded a decline of 20% in the three-month period ended August 2020 — the levels last witnessed in February 2016.

Recovery in Manufacturing Sector — A Ray of Hope

The U.S.-China trade tensions and waning global demand had taken a toll on the U.S manufacturing sector and the pandemic dealt a further blow to it. Per the Institute for Supply Management, the U.S Manufacturing Purchasing Managers’ Index (PMI) came in below 50 (which indicate contraction) from March to May. However, as businesses gradually resumed operations, the PMI crossed the 50 mark in June and remained above 50 for three straight months now. In fact, the PMI was 56% in August — the highest so far in 2020. Also, industrial production inched up 0.4% in August — the fourth consecutive monthly increase. Manufacturing output continued to improve in August, gaining 1%. A pick up in manufacturing activity will reflect on Caterpillar’s results.

Cost-Cutting Efforts to Sustain Margins

In September 2015, Caterpillar set out with significant restructuring and cost-reduction initiatives, which have now been substantially completed. The plan will likely lower annual operating costs by $1.5 billion. Also, in the wake of the coronavirus crisis, the company has taken actions to reduce costs, including reducing discretionary expenses, suspending 2020 base salary increases and short-term incentive compensation plans for many employees and all senior executives. Effective Jul 1, the company reinstated the 2020 base salary increases for employees except for the most senior executives. These efforts will help sustain margins amid low volumes.

Strong Balance Sheet, Digital Initiatives to Spur Growth

Caterpillar’s cash and liquidity position remains strong, with the company ending second-quarter 2020 with cash and short-term investments of $8.8 billion and available liquidity sources of $18.5 billion. The company currently has $11.1 billion in long-term debt with no maturities in 2020 and less than $1.4 billion in 2021. Caterpillar’s current ratio is at 1.50 and times interest earned ratio is currently at 5.8. These figures indicate that the company is in a good position to meet its debt obligations. So far this fiscal year, Caterpillar has returned $2.3 billion to shareholders through dividends and share buybacks. Although the company has suspended buyback plans due to the pandemic, it remains committed to maintaining its dividend.

Caterpillar also continues to focus on customers and on the future by continuing to invest in digital capabilities, connecting assets and jobsites, along with developing the next generation of more productive and efficient products. The company plans to fund initiatives that drive long-term growth focused on areas of expanded offerings and services, and digital initiatives like e-commerce. The company also continues to roll out new products in the market.

Price Performance

Caterpillar’s shares have gained 14.9% in the past year compared with the industry’s growth of 12.8%.

Zacks Rank & Stocks to Consider

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

Some better-ranked stocks in the Industrial Products sector include SiteOne Landscape Supply, Inc. (SITE - Free Report) , Fortune Brands Home Security, Inc. (FBHS - Free Report) and Cintas Corporation (CTAS - Free Report) . All of these stocks carry a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

SiteOne Landscape has an expected earnings growth rate of 18.5% for the current year. The stock has appreciated 56% in a year’s time.

Fortune Brands Home has a projected earnings growth rate of 6.2% for 2020. The company’s shares have gained 51% in a year.

Cintas has an estimated earnings growth rate of 1.4% for the ongoing year. The company’s shares have rallied 19% over the past year.

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