On Jul 12, 2016, we issued an updated research report on Caterpillar Inc. (CAT - Free Report) , the mining and equipment behemoth. We believe the cost-cutting measures and improvement in construction will bail out the company that is going through a rough patch grappling with weak mining and a post-Brexit uncertainty.
Caterpillar’s sales have been declining for 42 consecutive months, far worse than its last 19-month stretch of sales decline, spanning between Oct 2008 and Apr 2010 due to the global recession. In the wake of low commodity prices, mining customers have cut down their capital expenditures.
Moreover, due to the continued weakness in agriculture, sales of industrial engines will be down. Persistent economic weakness in China and Brazil also adds to the company’s woes.
At the end of the first quarter, Caterpillar’s backlog remained at $13.1 billion. On a year-over-year basis, order backlog fell by about $3.5 billion, having recorded decreases in all segments. This does not bode well for the second-quarter performance.
Due to consistently challenging business conditions in 2016, expectations of lower transportation sales (rail, marine and the end of production of on-highway vocational trucks), lower mining sales and weaker price realization, Caterpillar now expects revenues in the range of $40–$42 billion. The midpoint of revenues reflects a 13% drop from 2015 revenues of $47 billion. If the guidance is realized, the company’s revenues would drop for four years in a row for the first time in its nine decades of operations.
Finally, UK’s decision to leave the EU is a blow to Caterpillar as it is one of the largest bases for the company outside the U.S. The UK businesses export a significant portion of their manufactured products to a wide variety of customers and markets across Europe and other parts of the world, eased by the E.U.'s open market and standing trade agreements. Almost 25% of Caterpillar's sales and revenue come from its European business. The Brexit jeopardizes Caterpillar’s access to the European markets and would hurt its revenues from the region.
To combat the hurdles from weak mining, Caterpillar has boosted its restructuring actions, which are expected to lead to annual savings of $1.5 billion in operating costs of which about $750 million of the savings is expected this year. The restructuring resulted in the elimination of approximately 5,300 positions since the September announcement through the first quarter of 2016.
Caterpillar has realized significant cost savings as a result of these actions. The company continues to contemplate facility consolidations and closures in order to right size its capacity needs and has announced the closure or consolidation of about 15 facilities.
Another ray of hope for the company is that construction-related activity is picking up. The Architecture Billings Index, which is considered a leading indicator of U.S. non-residential construction, has remained above 50 in the recent months, signaling robust conditions ahead for the construction industry. Improvement in the construction sector will help to partially offset the impact of the weak mining sector.
Caterpillar repurchased approximately $2 billion of its common stock during 2015. No repurchases were made in the first quarter. Caterpillar ended the quarter with cash and short-term investments of $5.9 billion, while its debt-to-capital ratio at ME&T was 37.7%, marking an improvement over 39% at 2015 end and within its targeted range of 30–45%. Further share repurchases will be accretive to earnings.
Caterpillar currently carries a Zacks Rank #3 (Hold).
Key Picks from the Sector
Some better-ranked stocks within this industry include Astec Industries, Inc. (ASTE - Free Report) , The Manitowoc Company, Inc. (MTW - Free Report) and Alamo Group, Inc. (ALG - Free Report) . All of these stocks carry a Zacks Rank #2 (Buy).
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