Caterpillar (CAT) Gains on Q2 Earnings Beat, Hikes ’18 View

Caterpillar Inc. CAT delivered adjusted earnings per share of $2.97 in second-quarter 2018, soaring 99% from the prior-year quarter’s figure of $1.49 per share. This can be attributed to continued strength in many of its end markets as well as incessant focus on cost control. Earnings also surpassed the Zacks Consensus Estimate of $2.66 by a margin of 12%. The quarterly performance marked the company’s sixth consecutive quarter of both top and bottom-line growth after a string of dismal performances for four years. Following the upbeat results, Caterpillar’s shares advanced 3.44% in pre-market trading.

Including one-time items, Caterpillar reported earnings per share of $2.82 in the quarter compared with $1.35 per share in the prior-year quarter.

Revenues improved 24% year over year to $14.0 billion in the quarter under review, surpassing the Zacks Consensus Estimate of $13.7 billion. The company witnessed higher sales volume due to improved end-user demand across all segments particularly, Construction. Sales increased across all regions with Asia/Pacific and North America leading the pack.

In second-quarter quarter, cost of sales increased 21% year over year to $9.4 billion. Gross profit advanced 30% to $4.6 billion. Favorable price realization was partially offset by higher manufacturing costs triggered by increased freight and material costs. This was negated to some extent by lower warranty expense. Freight costs were unfavorable primarily due to supply chain inefficiencies as the industry responds to strong global demand while increases in steel prices triggered the rise in material costs.

Selling, general and administrative (SG&A) expenses increased 10% to $1.4 billion. Research and development (R&D) expenses inched up 1% year over year to $462 million. Adjusted profit before taxes came in at $2.7 billion, an improvement from the prior-year quarter figure of $1.8 billion.

Machinery and Energy & Transportation (ME&T) sales surged 25% year over year to $13.3 billion. Sales of Energy & Transportation gained 20%, owing to higher sales across all applications. Favorable currency impacts, mostly from a stronger euro, and favorable price realization also contributed to the increase in sales. Sales at Resource Industries improved 38% driven by higher end-user demand for equipment in all regions. Construction Industries sales rose 24% on the back of higher sales volume for construction equipment, currency impacts, primarily due to a stronger Chinese yuan and euro, partially offset by unfavorable price realization.

The ME&T segment delivered an operating profit of $2.1 billion, substantial improvement from $1.1 billion in the year-ago quarter. At the Energy & Transportation segment, operating profit improved 46% to $1,012 billion driven by higher sales volume and favorable price realization, partially offset by higher short-term incentive compensation expense and targeted investments.

The Resource Industries reported operating profit of $411 million in the quarter, a 315% surge from $99 million in the prior-year quarter thanks to higher sales volume and favorable price realization. Construction Industries’ profit increased 28% to $1.2 billion due to higher sales volume, partially negated by unfavorable price realization, higher material and freight costs as well as increased SG&A and R&D expenses.

Financial Products’ revenues went up 7% to $829 million due to higher average financing rates in North America and higher average earning assets in Asia-Pacific and North America, partially offset by lower intercompany lending activity in North America and lower average earning assets in Latin America.

Financial Products' profits were $134 million in the quarter, down from $191 million in the prior-year quarter. Increase in the provision for credit losses at Cat Financial, partially offset by a rise in net yield on average earning assets and a favorable impact from higher average earning assets led to the decline in profit for the quarter.

Caterpillar ended the second quarter 2018 with cash and short-term investments of $8.7 billion, up from $8.3 billion at 2017 end. ME&T operating cash flow for the quarter was $2.1 billion.

Caterpillar repurchased $750 million of shares in the reported quarter. As of Jun 30, 2018, $4.2 billion remained on the current authorization, which expires at 2018-end. In July 2018, its board of directors authorized the repurchase of up to $10 billion of Caterpillar common stock effective Jan 1, 2019, with no expiration date.

At the end of second-quarter 2018, Caterpillar’s backlog was at $17.7 billion, a $2.9 billion improvement year over year aided by increase at all segments.

Backed by strong first-half 2018 performance, healthy order rates, backlog and improving end-markets, Caterpillar now expects adjusted earnings per share between $11.00 and $12.00 for fiscal 2018. The company had earlier provided adjusted earnings per share guidance of $10.25-$11.25 for the fiscal.

However, the recently imposed tariffs will inflate material costs in the second half of the year by approximately $100 million to $200 million. Moreover, supply chain challenges will continue to pressure freight costs. However, Caterpillar plans to mitigate these impacts through mid-year price increases and utilizing the Operating & Execution Model to drive operational excellence and structural cost discipline.

Over the past year, the Caterpillar stock has underperformed the industry it belongs to. The company has delivered a return of 25%, while the industry grew 27%.

Caterpillar currently sports a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Other top-ranked stocks worth considering in the same sector include W.W. Grainger, Inc. GWW, Chart Industries, Inc. GTLS and Terex Corporation TEX. While Grainger and Chart Industries Services sport a Zacks Rank #1, Terex carries a Zacks Rank #2.

Grainger has a long-term earnings growth rate of 12.5%. The stock has appreciated 104% in a year’s time.

Chart Industries has a long-term earnings growth rate of 26.9%. The company’s shares have been up 119% in a year.

Terex has a long-term earnings growth rate of 21%. Its shares have rallied 12% in the past year.

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