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Caterpillar to Benefit From Cost Cuts and Strategic Moves

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On Dec 27, we issued an updated research report on Caterpillar Inc. (CAT - Free Report) . The company’s global machine sales growth has been declining for the past few months, hitting the lowest point in November, which remains a concern. Caterpillar anticipates modestly lower sales compared with previous year as dealers continue to lower inventory. It is thus taking steps to reduce production to match dealer demand and will proactively increase production once order levels improve. Focus on strategic investments, cost cutting measures and growing offerings and services, and digital initiatives like e-commerce, will aid growth.

Retail Sales Declining

Caterpillar’s global retail sales for the three-month period ended November 2019 remained flat year over year — the worst performance so far this year. Sales growth was confined in the single-digit territory this year — levels last witnessed in 2017. The company has average growth rate of 5.3% during the January-October 2019 period, reflecting a sharp decline from the prior-year figure of 24.7%.

Lower Backlog & Demand to Hurt 2019 Results

Caterpillar’s order backlog came in at $14.6 billion, reflecting a sequential drop of $400 million. This does not bode well for fourth-quarter 2019 revenues. For the ongoing quarter, the company expects end-user demand to remain flat and dealers to make further inventory reductions thanks to the global economic uncertainty.

For 2019, Caterpillar’s adjusted EPS guidance for 2019 is pegged at $10.59-$11.09. The mid-point of the guided range reflects a decline of 3% from 2018. This guidance reflects lower end-user demand and dealers reducing their inventory.

Weak Manufacturing Sector a Deterrent

The U.S.-China trade war and waning global demand has taken a toll on the U.S manufacturing sector this year. Per the Institute for Supply Management’s latest report, the U.S Purchasing Managers’ Index (PMI) was 48.1% in November 2019 – the fourth straight month of contraction in the sector.  This contraction in the manufacturing sector is likely to impact Caterpillar’s performance.

Caterpillar Taking Proactive Steps to Counter Weak Demand

Caterpillar will continue to monitor end-user demand, commercial shipments, dealer inventory, orders and backlog and plans to adjust production levels accordingly. The company has been successful in reducing the lead times, which allows dealers to maintain lower levels of inventory. Further, shorter lead times allow both the company and its dealers to adapt quickly to changing market conditions. The company is also taking steps to reduce production to match dealer demand and will proactively increase production once order levels improve.

Restructuring, Expanded Offerings to Aid Performance

In September 2015, Caterpillar initiated significant restructuring and cost reduction initiative, which is expected to lower annual operating costs by about $1.5 billion. The company is focused on developing a more competitive and flexible cost structure and controlling discretionary spending.

Meanwhile, Caterpillar continues to focus on customers and 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 profitable growth focused on areas of expanded offerings and services and digital initiatives like e-commerce. It will also focus on connected assets, autonomous machines, and new engine technologies and machine programs. It will use Operating & Execution Model to divert resources to areas that represent the greatest opportunity for return on investments. Caterpillar expects to double ME&T services sales to $28 billion by 2026 and deliver higher adjusted operating margins through cycles of three to six percentage points above historical performance.

Price Performance

Caterpillar’s shares have gained 8.7% in the past six months compared with the industry’s growth of 7.5%.

Zacks Rank & Stocks to Consider

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

Some better-ranked stocks in the Industrial Products sector are Northwest Pipe Company (NWPX - Free Report) , Tennant Company (TNC - Free Report) and Cintas Corporation (CTAS - Free Report) . While Northwest Pipe Company and Tennant Company sport a Zacks Rank #1 (Strong Buy), Cintas carries a Zacks Rank #2 (Buy) at present. You can see the complete list of today's Zacks #1 Rank stocks here.

Northwest Pipe has an expected earnings growth rate of 15.8% for the current year. The stock has appreciated 29% over the past six months.

Tennant has a projected earnings growth rate of 29.8% for 2019. The company’s shares have gained 27% in the past six months.

Cintas has an estimated earnings growth rate of 15.7% for the ongoing year. In the past six months, the company’s shares have gained 13%.

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