Caterpillar (CAT) Raises 2014 Guidance on Q2 Earnings Beat

Mining and equipment behemoth Caterpillar Inc. (CAT) reported a 17% increase to $1.69 per share in its second-quarter earnings, trumping the Zacks Consensus Estimate of $1.51. Caterpillar’s shares went down 1.64% in the pre-market trading session as the market reacted to the decline in revenues yet again.

The company’s incessant efforts to cut down costs and continued deployment of operational improvement, in the Construction segment along with record profit from Energy & Transportation, helped mitigate the effect of lower mining-related sales on its profits. Caterpillar delivered the third quarter of positive earnings surprise following negative earnings surprises in four straight quarters.

Including restructuring costs, earnings stood at $1.57 in the quarter, up 8% from $1.45 in the prior-year quarter.

Revenues Dip yet Again Due to Lower Mining Demand

Revenues declined 3% year over year to $14.1 billion in the quarter, falling short of the Zacks Consensus Estimate of $14.4 billion. Weaker results from the Resource Industries segment offset improvement in the Construction Industries. Sales in Energy & Transportation and Financial Products segments remained flat year over year.

Lower end-user demand for mining equipment continued to affect volumes in Resource Industries, as customers trimmed their capital expenditures. Aftermarket parts sales remained flat compared with the year-ago quarter.

Geographically, North America was the only saving grace where sales increased as against declined sales in the other regions. In North America, Caterpillar witnessed a 6% increase in sales triggered by improving demand for construction equipment in the United States.

Sales in Asia/Pacific declined 14%, dragged down by lower mining sales, timing of large Energy & Transportation projects and a slowing construction equipment industry in China. Latin America registered a 16% drop mainly due to lower end-user demand for mining equipment. Sales in Europe, Africa and Middle East (EAME) were about flat.

Costs & Operating Profit

Cost of sales declined 5% to $10.2 billion in the quarter due to favorable material costs. Gross profit increased 3% year over year to $3.95 billion in the quarter. Selling, general and administrative (SG&A) expenses remained flat at $1.4 billion while research and development (R&D) expenses were cut down 6% to $516 million. Adjusted operating profit was $1.59 billion, flat year over year as lower sales volume were offset by lower manufacturing costs and favorable price realization.

Segment Results – Resource Industries Drags down Overall Performance

Machinery, Energy & Transportation (ME&T) sales declined 4% year over year to $13.4 billion. Resource Industries’ sales plunged 29% owing to lower end-user demand across all regions. Construction Industries’ sales increased 11% primarily due to the favorable impact of changes in dealer inventories and increases in dealer deliveries to end user. Sales in Energy & Transportation were about flat.

The segment’s operating profit decreased 5% to $1.32 billion in the quarter. An impressive 83% increase in profits in the Construction Industries’ segment (attributed to higher sales volume, lower manufacturing costs, favorable currency and improved price realization) and a 6% increase in the Energy & Transportation segment were offset by 75% plunge in Resource Industries.

Financial Products’ net revenues increased 3% to $759 million, driven by the positive impact of higher average earning assets in North America, EAME and Latin America, partially offset by decreases in Asia/Pacific. Financial Products’ profits increased 5% to $244 million from $233 million in the second quarter of 2013.

The increase was mainly due to the absence of the $23 million currency loss in the prior year quarter and a $17 million favorable impact from higher average earning assets. However, these benefits were partially offset by the absence of $23 million in favorable reserve adjustments in the second quarter of 2013 at Insurance Services.

Financial Position

Caterpillar ended the second quarter of 2014 with cash and short-term investments of $7.9 billion, up from $6.1 billion at 2013 end. Total debt-to-capital ratio was at 66% as of Jun 30, 2014 compared with 64% as of Dec 31, 2013. The debt-to-capital ratio at ME&T was 32.5% as of Jun 30, 2014 compared with 29.7% as of Dec 31, 2013.

Total cash flow from operating activities in the first half of fiscal 2014 was $4.1 billion compared with $4.6 billion in the prior-year comparable period. Operating cash flow at ME&T was $2.06 billion in the reported quarter, down from $3.05 billion in the prior-year quarter.

Caterpillar returned $2.5 billion to shareholders through dividend payments of $0.7 billion and share repurchases of $1.7 billion.

Caterpillar announced its intention to repurchase approximately $2.5 billion of its common stock during the third quarter of 2014. This is part of the $10 billion stock repurchase authorization previously approved by board of directors in the first quarter of 2014. In the second quarter, the company increased its dividend by 17%.

Backlog

At the end of the quarter, Caterpillar’s backlog was $19.3 billion, flat sequentially. The increase was noted in Energy & Transportation, while backlog in Resource Industries and Construction Industries declined.

Guidance for 2014: Revenues Trimmed but Earnings Increased

Caterpillar revised its 2014 revenue guidance to a range of $54 to $56 billion. The company had earlier projected a range of $56 billion, up or down 5% which translated to a range of $53.2 to $58.8 billion. The trimmed guidance reflects lower sales of construction equipment in developing countries.

Excluding restructuring costs, earnings per share are now expected at $6.20, up from the prior forecast of $6.10, taking into account the upbeat Q2 numbers.

Caterpillar projects world economic growth to improve from 2% in 2013 to about 2.5% in 2014. However, Caterpillar expects that the developed economies will continue to improve while developing economies will remain challenged.

Our Take

Caterpillar has initiated extensive cost-saving programs across its global businesses and will continue to benefit from additional restructuring actions in 2014 to optimize its cost structure and improve its operational efficiency. Caterpillar will also benefit from the ongoing recovery in the U.S. construction sector as well as from share repurchases. However, a muted mining capex continues to bother this mining equipment giant.

Peoria, IL-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.

Peer Performance

Terex Corp. (TEX) reported second-quarter 2014 adjusted earnings of 76 cents per share, up 18.8% from 64 cents in the year-ago quarter. Earnings however fell short of the Zacks Consensus Estimate of 80 cents.

Caterpillar currently holds a Zacks Rank #2 (Buy). Some other stocks in the sector worth considering include Komatsu Ltd. (KMTUY) and H&E Equipment Services Inc. (HEES). While Komatsu sports a Zacks Rank #1 (Strong Buy), H&E Equipment carries a Zacks Rank #2 (Buy).