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Caterpillar (CAT) Up 10.3% Since Last Earnings Report: Can It Continue?

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It has been about a month since the last earnings report for Caterpillar (CAT - Free Report) . Shares have added about 10.3% in that time frame, outperforming the S&P 500.

Will the recent positive trend continue leading up to its next earnings release, or is Caterpillar due for a pullback? Before we dive into how investors and analysts have reacted as of late, let's take a quick look at its most recent earnings report in order to get a better handle on the important catalysts.

Caterpillar Q3 Earnings Top Estimates on Robust Demand
 
Caterpillar delivered adjusted earnings per share of $2.86 in third-quarter 2018, which rose 47% year-over-year driven by continued strength in many of its end markets and incessant focus on cost control. Earnings also surpassed the Zacks Consensus Estimate of $2.83. The quarterly performance marked the company’s seventh consecutive quarter of both top and bottom-line growth after a string of dismal performances over a period of four years.
 
Despite upbeat results, Caterpillar’s shares dipped 7% in pre-market trading as it maintained its guidance for 2018. This can be attributed to increased material costs due to tariffs and supply chain challenges which are likely to dent its results for the year.
 
Including one-time items, Caterpillar’s third-quarter earnings per share came in at $2.88 compared with $1.77 per share in the prior-year quarter. Notably, this was a third-quarter record.
 
Improved End Markets Drive Revenues 
 
Revenues improved 18% year over year to $13.5 billion in the quarter under review, surpassing the Zacks Consensus Estimate of $13.2 billion. The company witnessed higher sales volume due to improved end-user demand across all segments, including an increase in dealer inventories. However, unfavorable currency impacts, primarily owing to a weaker Australian dollar and Brazilian real were a minor concern. Sales increased across all regions, led by Asia/Pacific and North America with an increase of 28% and 22%, respectively. Sales in Latin America rose 10% while EAME witnessed an increase of 6%.
 
Higher Sales Lead to Improved Profits
 
In third-quarter, cost of sales increased 18% year over year to $94 billion due to higher manufacturing costs. This can be attributed to higher freight costs as a result of supply chain inefficiencies while increases in steel prices and tariffs triggered the rise in material costs. Gross profit advanced 20% to $4.5 billion.
 
Selling, general and administrative (SG&A) expenses increased 4% to $1.3 billion. Research and development (R&D) expenses went up 4% year over year to $479 million. Operating profit came in at $2.1 billion, an improvement from the prior-year quarter figure of $1.5 billion aided by higher sales volume and favorable price realization.
 
All Segments Deliver Growth
 
Machinery and Energy & Transportation (ME&T) sales surged 19% year over year to $12.8 billion. Sales of Energy & Transportation gained 15% to $5.6 billion from the prior-year quarter, driven by higher sales volume across all applications except Industrial. Sales at Resource Industries improved 35% year over year to $2.6 billion aided by higher demand for both mining and heavy construction equipment. Construction Industries sales rose 16% year over year to $5.7 billion on the back of higher sales volume for construction equipment.
 
The ME&T segment delivered an operating profit of $2.1 billion, an improvement of 43% from $1.4 billion in the year-ago quarter. At the Energy & Transportation segment, operating profit improved 31% to $973 million on higher sales volume which was partially offset by higher manufacturing costs and increased SG&A/R&D expenses.
 
The Resource Industries reported operating profit of $414 million in the third quarter, an 81% surge from $229 million in the prior-year quarter thanks to higher sales volume and favorable price realization. However, higher manufacturing costs and increased SG&A and R&D expenses were causes of concern. Construction Industries’ profit increased 20% to $1.1 billion due to higher sales volume, partially negated by higher manufacturing costs.
 
Financial Products’ revenues went up 9% to $845 million due to higher average financing rates in North America and higher average earning assets in Asia-Pacific and North America as well as a favorable impact from returned or repossessed equipment. However, these gains were partially offset by lower intercompany lending activity in North America and lower average earning assets in Latin Americaand lower average financing rates in Europe.
 
Financial Products' profits were $201 million in the reported quarter, up from $185 million in the prior-year quarter. Favorable impact from returned or repossessed equipment, higher average earning assets and an increase in net yield on average earning assets were partially offset by an unfavorable impact from available for sale securities in Insurance Services.
 
Cash Position
 
Caterpillar ended the third quarter of 2018 with cash and short-term investments of $8 billion, down from $8.3 billion at 2017 end. ME&T operating cash flow for the quarter under review was $848 million.
 
During the third quarter, the company made $1 billion to pension plans, repurchased $750 million of its common stock and a made a dividend payout of $511 million.
 
Robust Backlog
 
At the end of third-quarter 2018, Caterpillar’s backlog was at $17.3 billion, a $1.9 billion improvement year over year aided by increase at all segments.
 
Guidance Maintained
 
Backed by performance so far in 2018, healthy order rates, backlog and improving end-markets, Caterpillar maintained adjusted earnings per share guidance at $11.00-$12.00 for fiscal 2018. The company anticipates price realization, operational excellence and cost discipline to help offset the impact of higher material and freight costs, including tariffs on fourth-quarter results. For fiscal 2018, the company estimates the impact of recently imposed tariffs to be at the low end of the previously provided range of $100 million to $200 million.
 
Supply chain challenges will continue to pressure freight costs. The sudden spike in demand has led to supply chain challenges across the industry. Although the company is making efforts to improve material flows, constraints remain for some parts and components that are impacting lead times and availability. Caterpillar plans to mitigate these impacts through price increases and utilizing the Operating & Execution Model to drive operational excellence and structural cost discipline.
 
Caterpillar added that it will implement a price hike of 1-4% worldwide on machines and engines with exceptions on specific products and regions. This price action will be effective in January 2019.
 

How Have Estimates Been Moving Since Then?

In the past month, investors have witnessed an upward trend in fresh estimates.

VGM Scores

Currently, Caterpillar has a nice Growth Score of B, though it is lagging a bit on the Momentum Score front with a C. However, the stock was allocated a grade of A on the value side, putting it in the top 20% for this investment strategy.

Overall, the stock has an aggregate VGM Score of A. If you aren't focused on one strategy, this score is the one you should be interested in.

Outlook

Estimates have been broadly trending upward for the stock, and the magnitude of these revisions looks promising. Notably, Caterpillar has a Zacks Rank #3 (Hold). We expect an in-line return from the stock in the next few months.




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