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Lackluster 1Q Earnings for Caterpillar

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Reduced mining demand coupled with a decline in inventory led to a 45% slump in first quarter 2013 earnings of construction and mining equipment behemoth, Caterpillar Inc. (CAT - Free Report) to $1.31 per share. Reported earnings also trailed the Zacks Consensus Estimate of $1.34.

Revenues declined 17% to $13.2 billion in the quarter, falling short of the Zacks Consensus Estimate of $13.6 billion. Sales volume decreased $2.671 billion, mainly due to the impact of changes in dealer new machine inventories. Dealers reduced inventories by about $700 million in contrast to an increase of about $875 million in the prior-year quarter. A net negative impact of acquisitions and divestitures of $171 million and $91 million unfavorable currency impact further dragged down results. However, increased price realization of $129 million was the only bright spot in the quarter.

Caterpillar witnessed lower sales across all regions with Asia Pacific suffering the worst (down 21% year over year), closely followed by North America registering a 20% fall. Sales in EAME and Latin America declined 16% and 5%, respectively. Even though sales declined overall in Asia Pacific, sales increased in China and remained flat in Japan.

Cost of sales declined 14% to $9.6 billion in the quarter. Selling, general and administrative (SG&A) expenses increased 4% to $1.39 billion and research and development (R&D) expenses went down 4% to $562 million.

Adjusted operating profit was $1.6 billion, a decline of 43% from $2.8 billion in the first quarter of 2012. Lower volume, increased manufacturing costs, unfavorable impact from acquisitions and divestitures, partially offset by increased operating profit at Financial Products and the favorable impact of currency mainly due to the Japanese yen, led to the overall decline in operating profit.

Segment Results

Machinery and Power System (M&PS) revenues decreased 18% to $12.5 billion. Resource Industries’ sales plunged 23% affected by lower dealer new machine inventories. Construction Industries’ sales plummeted 17% affected by lower volume and the unfavorable impact of currency, partially offset by favorable price realization. Power Systems’ sales also fell 12% on lower volumes.

Financial Products’ revenues increased 4% to $795 million as the positive impact of higher average earning assets and increase in Cat Insurance revenues were offset by an unfavorable impact of lower average financing rates on new and existing finance receivables and operating leases. Financial Products’ profits, however, increased to $273 million from $205 million in the first quarter of 2012. The increase was attributed to a $49 million impact from lower claims experience at Cat Insurance and a $34 million favorable impact of higher average earning assets.

Financial Position

As of Mar 31, 2013, Caterpillar had cash and short-term investments of $5.98 billion, up from $5.49 billion as of Dec 31, 2012. Total debt-to-capital ratio improved to 69% as of Mar 31, 2013 from 70% as of Dec 31, 2012. The debt-to-capital ratio at M&PS decreased to 36.4% as of Mar 31, 2013 compared with 37.4% as of Dec 31, 2012.

Total cash flow from operating activities in the first quarter was $1.4 billion compared with $315 million in the prior-year quarter. Operating cash flow at M&PS increased significantly to $1.098 billion in the first quarter from $234 million billion in the prior-year quarter, mainly due to changes in inventory, higher short-term incentive compensation payments, offset by lower profit and changes in accounts payable and customer advances.

Fiscal 2013 Outlook

Citing weak demand for its mining equipment, Caterpillar has trimmed its sales outlook to a range of $57 to $61 billion from the previous $60 to $68 billion. Caterpillar now expects to earn $7.00 per share in 2013, down from the earlier projection of earnings between $7.00 and $9.00 per share.

Caterpillar expects overall world economic growth of about 2.5%, a tad improvement from 2.3% in 2012. U.S. economic growth is projected at 2.5% in 2013. China's economy is expected to improve 8%, up from 7.8% in 2012. Construction activity is increasing in the region and is expected to remain so for the balance of the year. Economic growth in both Africa/Middle East and CIS will be over 3.5% in 2013, similar to growth rates achieved in 2012. The Eurozone economy is expected to decline 0.5%. However, the rest of Europe is expected to witness modest growth, leading to a marginal growth across Europe in 2013.

Resumption of Stock Repurchase

Caterpillar’s Board of Directors had authorized the repurchase of $7.5 billion worth of common stock of its stock in Feb 2007, and consequently in Dec 2011 was extended through Dec 2015. Till 2008, Caterpillar had expended $3.8 billion of the $7.5 billion authorization and no shares of stock have been repurchased since then. Caterpillar has now decided to resume the program given the recent decline in the Caterpillar stock price combined with balance sheet strength and positive cash flow. Caterpillar plans to resume the share repurchases in the second quarter and repurchase about $1 billion of stock under the existing authorization.

Our Take

The weaker-than-expected earnings is not a surprise as Caterpillar had earlier hinted that that first quarter 2013 sales will be significantly lower on a year-over-year basis as dealers were expected to continue to lower their new machine inventories to match demand. Reduced sales and the negative cost impact of continuing low production levels and declining inventory were expected to affect earnings.

Caterpillar sales started its downhill journey in Dec 2012, hurt by tougher year-earlier comparisons and rising inventories of unsold equipment. Caterpillar’s sales performance deteriorated 13% in February, worsening from the 4% and 1% dip reported in Jan 2013 and Dec 2012, respectively. Caterpillar had earlier witnessed negative sales growth in Apr 2010 and since then enjoyed a stint of positive growth, benefiting from strong equipment demand both domestically as well as in the emerging markets.

Owing to reduced global demand for mining equipment and to bring production in line with demand, Caterpillar recently announced plans to layoff of more than 400 employees or about 11% of its work force at its Decatur, Ill., factory.

Caterpillar’s results have borne the brunt of continued economic turmoil in Europe and its domino effect on the rest of the world. Caterpillar remains affected by slowing demand and inventory correction as a result of overproduction compared to demand. Caterpillar is struggling to bring production under control. Even though Caterpillar will benefit from the recovery in the U.S. construction sector, the recent loss of sales momentum, declining backlog, negative impact of the European debt crisis remain concerns.

Peoria, Ill.-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 #5 (Strong Sell). Its peers, Joy Global, Inc. , H&E Equipment Services Inc. (HEES - Free Report) and The Manitowoc Company, Inc. (MTW - Free Report) are yet to announce their first quarter results.

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