Caterpillar Inc. UNDERPERFORM ZACKS CONSENSUS ESTIMATES (CAT-NYSE)

Transcription

1 February 25, 2015 Caterpillar Inc. (CAT-NYSE) Current Recommendation Prior Recommendation Neutral Date of Last Change 02/22/2015 Current Price (02/24/15) $84.50 Target Price $77.00 SUMMARY DATA UNDERPERFORM 52-Week High $ Week Low $79.85 One-Year Return (%) Beta 1.70 Average Daily Volume (sh) 6,450,947 Shares Outstanding (mil) 605 Market Capitalization ($mil) $51,123 Short Interest Ratio (days) 4.93 Institutional Ownership (%) 66 Insider Ownership (%) 1 Annual Cash Dividend $2.80 Dividend Yield (%) Yr. Historical Growth Rates Sales (%) 10.1 Earnings Per Share (%) 16.3 Dividend (%) 11.2 using TTM EPS 13.2 using 2015 Estimate 17.7 using 2016 Estimate 17.1 Zacks Rank *: Short Term 1 3 months outlook 5 - Strong Sell * Definition / Disclosure on last page SUMMARY Caterpillar s fourth-quarter earnings per share declined 20% to $1.35 due to a muted mining environment and lower prices of oil and key mined commodities, particularly copper, coal and iron ore. For 2015, the company now expects revenues to be around $50 billion and earnings per share of $4.75. Caterpillar reduced its guidance due to lower oil prices, weak mining, lowered expectations for Chinese construction equipment demand as well as a stronger dollar. Moreover, a declining backlog, weak agriculture sector, increased R&D expenses, continued sales decline and the recent SEC investigation remain headwinds. We have maintained our underperform recommendation on Caterpillar with a target price of $77. Risk Level * Average, Type of Stock Large-Blend Industry Mach-Const/Mng Zacks Industry Rank * 248 out of 267 ZACKS CONSENSUS ESTIMATES Revenue Estimates (In millions of $) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) ,210 A 14,621 A 13,423 A 14,402 A 55,656 A ,241 A 14,150 A 13,549 A 14,244 A 55,184 A ,853 E 13,283 E 12,082 E 12,206 E 50,424 E ,170 E Earnings Per Share Estimates (EPS is operating earnings before non-recurring items, but including employee stock options expenses) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2013 $1.32 A $1.48 A $1.49 A $1.68 A $5.97 A 2014 $1.61 A $1.69 A $1.72 A $1.35 A $6.38 A 2015 $1.36 E $1.40 E $1.08 E $0.94 E $4.78 E 2016 $4.93 E Note: 2014 Quarterly Figures do not add up due to rounding off Projected EPS Growth - Next 5 Years % Zacks Investment Research, All Rights reserved S. Riverside Plaza, Chicago IL 60606

2 OVERVIEW Caterpillar Inc. (CAT) is the world s leading manufacturer of construction and mining equipment, diesel and natural gas engines and industrial gas turbines. It is also a leading exporter in the U.S. with more than half of its sales being generated outside the United States. Through its global network of independent dealers, Caterpillar builds long-term relationships with customers around the world. Caterpillar operates through two divisions Machinery & Energy & Transportation systems and Financial Products. Machinery, Energy & Transportation (Approximately 94% of total revenue in the 2014) This segment represents the aggregate of Construction Industries, Resource Industries, Energy & Transportation and All Other Segments and related corporate items and eliminations. Construction Industries This segment is responsible for small and core construction machines. Its product portfolio includes backhoe loaders, small wheel loaders, small and medium track-type tractors, skid steer loaders, multi-terrain loaders, mini excavators, compact wheel loaders, select work tools, small, medium and large track excavators, wheel excavators, medium wheel loaders, track-type loaders, motor graders and pipe layers. In addition, the Construction Industries segment is responsible for the Power Systems and components in Japan and an integrated manufacturing cost center that supports the Machinery and Power Systems businesses. Resource Industries This segment takes care of the business strategies, product design, product management and development, manufacturing, marketing and sales along with product support for large track-type tractors, hard rock vehicles, longwall and highwall miners, electric rope shovels, draglines, hydraulic shovels, drills, large wheel loaders, large mining, off-highway and articulated trucks, wheel tractor scrapers, wheel dozers, select work tools, machinery components and electronics and control systems. Energy & Transportation This segment, formerly known as Power Systems, supports customers by providing them with reciprocating engines, turbines, diesel-electric locomotives and related parts across industries, catering to power generation, industrial, oil and gas and transportation applications. It also manages marine and rail-related businesses. All Other Segments These segments primarily include activities such as the re-manufacturing of CAT engines and components and re-manufacturing services for other companies as well as product management, development, manufacturing, marketing and product support of undercarriages, specialty products, hardened bar stock components and ground engaging tools, paving products, forestry products, industrial and waste products and tunnel-boring equipment. Financial Products Segment (Approximately 6% of total revenue in 2014) This segment provides financing to customers and dealers for the purchase and lease of Caterpillar and other equipment. It also offers financing for Caterpillar sales to dealers. Its financing plans include operating and finance leases, installment sale contracts, working capital loans and wholesale financing plans. This division also provides various forms of insurance to customers and dealers to facilitate the purchase and lease of equipment. Equity Research CAT Page 2

3 REASONS TO SELL We have downgraded our recommendation on Caterpillar from neutral to underperform as its estimates are undergoing negative revisions following its fourth-quarter results and reduced guidance for Caterpillar reported a 20% decline in its fourth-quarter 2014 adjusted earnings to $1.35 per share due to a muted mining environment and lower prices of oil and key mined commodities. Caterpillar now anticipates 2015 revenue to be approximately $50 billion (down 4% yoy) from the prior expectation of flat to slightly up. The primary reason being lower oil prices, which will negatively impact both engine sales for oil production, as well as lower demand for construction machines used for energy site preparations. Lower mined commodity prices which have a direct impact on Resource Industries, lowered expectations for Chinese construction equipment demand as well as a stronger dollar also led to the decline in expectations. With continued weakness in agriculture, the company is also expecting lower sales of industrial engines, while the rail business is also projected to be down in 2015 after a great At the end of the fourth quarter, Caterpillar s backlog was $17.3 billion, down from $19.7 billion at the end of the third quarter. The decrease was primarily in Energy & Transportation followed by the Resource Industries and Construction Industries. Backlog is further expected to decline in the Energy & Transportation segment during the first half of Caterpillar expects higher research & development expenses to be a headwind in 2015 as the company continues to invest in new and updated products, and increase work on new technologies, that have applications across the company, in order to stay competitive. Cost absorption from lower inventory is also expected to be a headwind. With the decline in sales, the company expects more inventory reduction in 2015 than in The company also expects adverse mix to affect sales as sales of high margin products like those in oil and gas will weaken. Caterpillar reported a 14% decline in its global retail sales for the three months ending Jan January marked the 26th consecutive month of declining sales for the company, worse than the previous 20-month stretch of negative sales reported from Sep 2008 to Apr 2010 due to the global recession. Caterpillar is being investigated by the SEC regarding its movement of cash between its business units in the U.S. and overseas. Additionally, the SEC is conducting an informal investigation of the company's affiliate in Switzerland called Caterpillar SARL. Caterpillar's tax strategy related to Caterpillar SARL had previously also come under scrutiny as it was alleged that the company was Equity Research CAT Page 3

4 using the Swiss affiliate to transfer the rights to profits from its parts business in order to avoid taxes. Even though the company stated that the probe will not have any effect on its business or finances, it will have a negative impact on its reputation. Caterpillar incurred restructuring costs of $441 million in 2014, mostly related to the reduction of headcount at the Gosselies, Belgium facility. In 2015, there will be further costs from programs started in 2014 and an additional cost of about $150 million. The biggest chunk of restructuring being the Belgium construction reorganization. Most of the benefit will not be realized until late 2015 and The full $500 million benefit from the restructuring announced this year will not totally hit on an annualized basis until Till then it will affect margins. RISKS Caterpillar repurchased shares worth $4.2 billion in the year. At the end of 2014, the company had $7.5 billion remaining under the authorization. It ended 2014 with cash and short-term investments of $7.3 billion while its debt-to-capital ratio at ME&T was 37.4%, within its targeted range of 30% to 45%. Further share repurchases will be accretive to earnings in 2015 and provide support to the stock. 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. The improvement in the construction sector will somewhat help compensate the impact of the weak mining sector. Caterpillar expects lower incentive compensation in The company also anticipates variable manufacturing cost to be favorable in 2015 driven by its continuous efforts to reduce costs and improve efficiency as well as lower material costs. These will be accretive to margins. RECENT NEWS Caterpillar s January Sales Dip 14% - Feb 17, 2015 Caterpillar reported a 14% decline in its global retail sales for the three months ending Jan 2015, tumbling further than the maximum decline of 13% witnessed last year. January marked the 26th consecutive month of declining sales for Caterpillar, far poorer than the previous 20-month stretch of negative sales reported from Sep 2008 to Apr 2010 due to the global recession. This time, sales growth were in the red since Dec 2012, affected by rising inventories of unsold equipment, weak economic conditions and slow down of the Chinese economy, which had earlier been the main driver of construction and mining demand. In January, sales declined mainly due to a slump in Latin America (down 36%) with Asia Pacific in tow with a 19% dip. EAME declined 8% and North America was also down by 5%. In 2014, North America was the only region that consistently delivered positive growth. Overall sales in Resource Industries were down 27% with sales in the red across all regions. This does not come as a surprise since sales in Resource Industries will remain soft as mining companies have slashed spending in the face of lower commodity prices. Latin America fared the worst with a 43% slump, Equity Research CAT Page 4

5 followed by EAME with a decline of 30%. Sales in North America dipped 23% and in Asia/Pacific it went down 10%. Sales in Construction Industries were down 10% year over year. After delivering positive growth during most of 2014, the segment s sales growth slipped into the negative territory since August last year. North America sales were flat, while EAME was up 1%, which was offset by decline in Latin America and Asia/Pacific, which were down 33% and 22%, respectively. Sales in the Energy & Transportation segment moved north 22%. A 72% surge in the Transportation sector, 20% rise in the Oil & Gas sector and 18% increase in Power Generation sector were partially offset by a 15% decline in the Industrial segment sales. Caterpillar s Cash Movement Under SEC Probe - Feb 17, 2015 Caterpillar announced that the company is being investigated by the SEC regarding its movement of cash between its business units in the U.S. and overseas. The company had received a grand jury subpoena from the U.S. District Court for the Central District of Illinois in Jan 2015, asking for financial information related to undistributed profits of non-u.s. subsidiaries and cash movements. Caterpillar refrained from providing any further details but stated that is cooperating with the investigation. The company added that the probe will not have any effect on its business or finances. Additionally, the SEC is conducting an informal investigation of the company's affiliate in Switzerland called Caterpillar SARL. Caterpillar's tax strategy related to Caterpillar SARL had previously also come under scrutiny as it was alleged that Caterpillar was using the Swiss affiliate to transfer the rights to profits from its parts business in order to avoid taxes. Caterpillar Misses Q4 Earnings on Lower Commodity Prices - Jan 27, 2015 Mining and equipment behemoth, Caterpillar reported a 20% decline in its fourth-quarter 2014 adjusted earnings to $1.35 per share due to a muted mining environment, and lower prices of oil and key mined commodities, particularly copper, coal and iron ore. Results fell way short of the Zacks Consensus Estimate of $1.55, a negative earnings surprise of 13%. Caterpillar s shares went down 7.57% in the premarket trading session following the release. Including restructuring costs, earnings stood at $1.23 in the quarter, down 21% from $1.55 in the prior-year quarter. Revenues Revenues declined 1% year over year to $14.2 billion in the quarter but surpassed the Zacks Consensus Estimate of $14.1 billion. The year-over-year decline was mainly due to currency impacts from weakening of the euro and Japanese yen. Sales in Machinery, Energy & Transportation declined 1% and Financial Products sales dipped 2%. Geographically, in North America, Caterpillar recorded a 15% increase in sales triggered by higher demand for oil and gas and transportation applications and favorable impact of changes in dealer inventories. Sales in Europe, Africa and Middle East (EAME) increased 2% on the back of rise in deliveries to end users, offset by the unfavorable impact of changes in dealer inventories as well as currency exchange as sales in euros translated into fewer U.S. dollars. Latin America registered a 14% drop, mainly due to lower end-user demand for construction and mining equipment, partially offset by the favorable impact of changes in dealer inventories. Sales in Asia/Pacific declined 16%, due to lower demand for construction equipment and unfavorable impact of changes in dealer inventories. Equity Research CAT Page 5

6 Costs & Operating Profit In the quarter, cost of sales remained flat year over year at $10.5 billion, while gross profit decreased 3% year over year to $3.7 billion. Selling, general and administrative (SG&A) expenses increased 7% to $1.5 billion and research and development (R&D) expenses went up 24% to $578 million. Operating profit was at $1.06 billion, down 27% year over year, as increased SG&A and R&D expenses, resulting from new product introductions, higher manufacturing costs and incentive compensation expense, were offset by favorable price realization. Segment Results Machinery and Energy & Transportation (ME&T) sales decreased 1% year over year to $13.5 billion. Sales in Energy & Transportation went up 11% driven by increased sales for oil and gas, power generation and transportation applications, whereas sales of industrial applications dipped. Sales in Resource Industries declined 10%, due to lower end-user demand for mining equipment, partially offset by favorable impact of changes in dealer inventories. Construction Industries' sales declined 9% as lower volume and unfavorable impact of currency translation, primarily the Japanese yen and the euro, were partially offset by improved price realization. The segment s operating profit decreased 27% to $921 million in the quarter. Operating profit decreased 26% in the Construction Industries segment, owing to lower sales volume, increased incentive compensation expense and higher spending on new product introduction programs. Operating profit went up 10% in the Energy & Transportation segment on the back of higher sales volume, partially offset by spending on growth-related programs. However, operating profit in Resource Industries plunged 67%, because of lower sales volume, increased SG&A and R&D expenses. Financial Products net revenues decreased 1% to $811 million due to lower average financing rates in North America and Europe and lower average earning assets in Asia/Pacific, partially offset by higher average earning assets in North America. Financial Products profits declined 26% to $197 million in the quarter. Fiscal 2014 Performance Caterpillar s fiscal 2014 adjusted earnings came in at $6.38, which increased 7% from $5.97 in the prior fiscal but fell short of the Zacks Consensus Estimate of $6.55. Earnings, however, were better than the company s guidance of $5.85. Including one-time items, earnings came in at $5.88, rising 2% from $5.75 in fiscal Revenues declined 1% year over year to $52.1 billion, missing the Zacks Consensus Estimate of $54.8 billion as well as the company s guidance of $56 billion. Financial Position Caterpillar ended fiscal 2014 with cash and short-term investments of $7.3 billion, up from $6.1 billion as of 2013-end. Total debt-to-capital ratio was at 70% as of 2014-end compared with 64% as of 2013-end. The debt-to-capital ratio at ME&T was 37.4% as of Dec 31, 2014 compared with 29.7% as of Dec 31, Total cash flow from operating activities in fiscal 2014 was $8.1 billion compared with $10.2 billion in the prior year. Operating cash flow at ME&T was $7.5 billion in fiscal 2014, down from $9 billion in the prior year. Caterpillar repurchased shares worth $4.2 billion in the year. At the end of 2014, the company had $7.5 billion remaining under the authorization. Equity Research CAT Page 6

7 Backlog At the end of the fourth quarter, Caterpillar s backlog was $17.3 billion, down from $19.7 billion at the end of the third quarter. The decrease was primarily in Energy & Transportation followed by the Resource Industries and Construction Industries. Guidance for 2015 For 2015, the company expects revenues to be around $50 billion, reflecting the impact of relatively slow growth in the world economy and continued weakness in commodity prices, particularly oil, copper, coal and iron ore. The company guides earnings per share in the range of $4.75 per share. VALUATION Currently, shares of Caterpillar are trading at 17.7x our 2015 EPS estimate of $4.78. The company s trailing 12-month earnings multiple is 13.2x, compared with the 15.9x average for the peer group and 18.4x for the S&P 500. Over the last five years, Caterpillar shares have traded in the range of 8.9x to 30x trailing 12-month earnings. We have maintained our Underperform recommendation on Caterpillar, which indicates that it will perform below the market. Our target price is $77 or 16.1x our 2015 EPS estimate. Key Indicators F1 F2 Est. 5-Yr EPS Gr% P/CF 5-Yr High 5-Yr Low Caterpillar Inc. (CAT) Industry Average S&P Komatsu Ltd. (KMTUY) Terex Corp. (TEX) TTM is trailing 12 months; F1 is 2015 and F2 is 2016, CF is operating cash flow P/B Last Qtr. P/B 5-Yr High P/B 5-Yr Low ROE D/E Last Qtr. Div Yield Last Qtr. EV/EBITDA Caterpillar Inc. (CAT) Industry Average S&P Equity Research CAT Page 7

8 Earnings Surprise and Estimate Revision History Equity Research CAT Page 8

9 DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of CAT. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1126 companies covered: Outperform %, Neutral %, Underperform 8.1%. Data is as of midnight on the business day immediately prior to this publication. Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5 th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively. Equity Research CAT Page 9