Caterpillar’s 4Q Impressive, but an Unlucky 2013

Shares of Caterpillar Inc. (CAT) went up 6.8% in pre-market trading as the company reported a 5% increase in its fourth-quarter 2013 earnings to $1.54 per share — the only quarter in the fiscal 2013 to report a y-o-y growth.

Results outperformed the Zacks Consensus Estimate of $1.29 and with this earnings beat, the construction and mining equipment behemoth has broken the jinx of negative earnings surprises for straight four quarters. The company’s incessant efforts to cut down costs helped mitigate the effect of lower mining-related sales on its profits.

Including a goodwill impairment charge of 87 cents per share and a positive impact of tax settlement of 45 cents per share in the year-ago quarter, earnings were at $1.04. Compared to this base, earnings in the fourth quarter increased 48% year over year.

4Q Revenues Down Due to Lower Mining Demand, Beats Zacks Estimates

Revenues declined 10% to $14.4 billion in the quarter, but were well ahead of the Zacks Consensus Estimate of $13.5 billion. Drop in sales of new machines for mining continued to drag down revenues in the quarter. Weaker results from the Resource Industries segment mitigated the improvement in Construction Industries, Power Systems and Financial Products.

In the quarter, Caterpillar witnessed lower sales across all regions barring North America in the quarter which increased 7%. Asia/Pacific was the biggest sufferer (down 29% year over year) due to lower Australian mining sales. However, the 20% year-over-year sales increase in China was the bright spot. Latin America registered a 19% drop followed by Europe, Africa and Middle East (EAME) declining 8%.

Costs & Operating Profit in 4Q

Cost of sales declined 11% to $10.5 billion in the quarter, thanks to the company’s cost reduction initiatives. Likewise, selling, general and administrative (SG&A) expenses decreased 11% to $1.4 billion and research and development (R&D) expenses went down 24% to $467 million.

Operating profit was $1.452 billion, down 10% from an adjusted $1.618 billion in the fourth quarter of 2012. Benefits from lower manufacturing costs, decreased SG&A and R&D expenses and the favorable impact of currency were partially offset by lower sales volume, which included an unfavorable mix of products.

Segment Results in 4Q

Machinery and Power System (M&PS) revenues decreased 11% to $13.6 billion. Resource Industries’ sales plunged 48% owing to lower end-user demand across all regions. Construction Industries’ sales increased 20% driven by higher sales volume, partially offset by the unfavorable impact of currency and price realization. Power Systems’ sales increased 5% due to favorable changes in dealer inventories.

Machinery and Power System segment’s operating profit increased 37% to $1.27 billion in the quarter, dragged down by a 77% plunge in Resource Industries.

Financial Products’ net revenues increased 5% to $756 million, driven by the positive impact of higher average earning assets (barring Asia/Pacific). Financial Products’ profits increased to $266 million from $180 million in the fourth quarter of 2012. A $61 million decrease in the provision for credit losses at Cat Financial and a $16 million favorable impact from currency gains and losses led to the improvement.

Earnings and Revenues Dip in 2013, But Ahead of Consensus and Guidance

A fourth-quarter recovery was not sufficient to salvage Caterpillar’s fiscal 2013 results. In 2013, earnings per share were at $5.75, a 32% decline from $8.48 in the prior fiscal. Nevertheless, it beat the Zacks Consensus Estimate as well as the company guidance of $5.50.

Revenues dipped 16% to $55.6 billion from $65.8 billion in fiscal 2013 mainly due to decline in mining sales. It however outpaced the Zacks Consensus Estimate of $54.3 billion and the company’s guidance of $55 billion.

Financial Position

Caterpillar ended fiscal 2013 with cash and short-term investments of $6.1 billion, up from $5.5 billion as of fiscal 2012-end. Total debt-to-capital ratio improved to 64% as of Dec 31, 2013, from 70% as of Dec 31, 2012. The debt-to-capital ratio at M&PS improved substantially to 29.7% as of Dec 31, 2013, compared with 37.4% as of Dec 31, 2012. This was the lowest debt-to-capital ratio in over 25 years.

Total cash flow from operating activities in 2013 almost doubled to $10.2 billion from $5.2 billion in the prior fiscal. Operating cash flow at M&PS was a record at $9 billion in 2013, up from $4.2 billion in 2012, thanks to the $2.9 billion of inventory reduction during the year.

During the year, Caterpillar repurchased $2 billion of stock. The company intends to repurchase approximately $1.7 billion of its common stock during the first quarter of 2014 and complete its existing $7.5 billion repurchase authorization.

The authorization, approved by the Caterpillar’s board of directors in 2007, is slated to expire on Dec 31, 2015. In addition, Caterpillar’s board of directors has approved a new $10 billion stock repurchase program that will expire on Dec 31, 2018.

Caterpillar also hiked its quarterly dividend by 15% to 60 cents per share in 2013, marking the highest percentage increase in dividend since the financial crisis of 2008.

Backlog

At the end 2013, Caterpillar’s backlog was at $18 billion, down $1.1 billion sequentially and $2.2 billion year over year. The annual decline was due to reduction in order backlog for mining-related products in Resource Industries and a slight decline in Power Systems, which offset a substantial increase in Construction Industries.

Outlook for 2014

Caterpillar expects revenues in 2014 to be flat with 2013 or move up or down in a 5% range. Excluding restructuring costs, earnings per share is expected at $5.85. Construction Industries and Power Systems are expected to log sales growth on the heels of better economic growth. However, sales in Resource Industries will continue to be a deterring factor, as mining companies will continue to reduce their capital expenditures in 2014.

Economic indicators have shown improvement in many countries, which point toward a rebound in the world economy. Caterpillar projects world economic growth to improve from 2% in 2013 to about 3% in 2014. However, lingering risks and uncertainties such as the U.S. fiscal, monetary policy actions and unfavorable situations in Europe may hinder positives from leading to global economic growth.

Our Take

Caterpillar had been affected by slowing demand and inventory correction as a result of overproduction compared to demand. Caterpillar lowered its inventory by $2.9 billion in 2013, and dealers lowered their inventories by more than $3 billion. While these inventory reductions were a significant sales and production headwind for Caterpillar in 2013, their significant impact on its sales is now largely over.

To combat the decline in mining-related demand, Caterpillar remains focused on reducing costs by shifting production between certain facilities, rationalization of its smaller facilities, workforce reductions and reductions in program spending. Caterpillar’s cash flow has thus remained strong despite the drop in profits. Strong cash flow has enabled the company to improve its balance sheet, repurchase shares and raise its dividend and also reduce its debt level.

Meanwhile, Caterpillar has continued to build up its share of in the excavator market in China. Total sales and revenues in China in 2013 were about $3.5 billion, up more than 20% year over year, faring substantially better than the industry-wide decline of 3%. Caterpillar’s market share also increased to 12% in China. The Chinese excavator market is expected to grow and Caterpillar can capitalize on the demand, given its expanding market.

Even though Caterpillar will benefit from the recovery in the U.S. construction sector, declining backlog, continuing lower mining demand and 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 #3 (Hold). Some better-ranked stocks in the sector include Terex Corp. (TEX), Zebra Technologies Corp. (ZBRA) and Columbus McKinnon Corp. (CMCO). While Terex and Zebra Technologies hold a Zacks Rank #1 (Strong Buy), Columbus McKinnon holds a Zacks Rank #2 (Buy).