Caterpillar (CAT, Financial) is the world’s leading manufacturer of construction and mining equipment, diesel and natural gas engines, industrial gas turbines and diesel-electric locomotives. The company principally operates through its three product segments - Resource Industries, Construction Industries, and Energy & Transportation (formerly Power Systems) - and also provides financing and related services through its Financial Products segment. Caterpillar is also a leading U.S. exporter. Through a global network of independent dealers and direct sales of certain products, Caterpillar builds long-term relationships with customers around the world.
The company reported strong operational performance in 2014. Market share, quality and safety all improved and on slightly lower sales, profit per share in 2014 was 5.88 up from 5.75 in 2013. Excluding restructuring charges profit per share was up 7% to 6.38. Operating cash flow of $7.5 billion was the third best year in company history. The company continued to return cash to stockholders in 2014. It raised the dividend 17% in 2014 and also repurchased about $4.2 billion of stock in 2014.
However despite this strong performance, the company’s share are under pressure since the back half of 2014. The key culprit is the fall in oil prices which has impacted the company’s 2015 outlook. According to Caterpillar’s 2015 outlook that it released in the end of January, sales and revenues are expected to be about $50 billion in 2015, which is down about 9% from 2014 levels. Management expects continued weakness in commodity prices, particularly oil, copper, coal and iron-ore. The sales will be hurt by several factors but the single biggest factor is direct and indirect impacts from oil and gas price declines. About half of CAT's 2015 sales decline is expected to come from direct and indirect exposure to oil and gas. The other factors include decreases in mining, and the stronger U.S. dollar, decreases in locomotive sales, lower China construction industry and industrial engines.
For the year management expect profit per share of $4.60 and excluding restructuring costs at $4.75. On the positive side, lower incentive compensation expense, improved variable margin, lower restructuring costs, positive currency effects and slightly improved price realization are expected to help the company’s profitability.
In a nut shell, 2015 is going to be a tough year for Caterpillar. However, this is already factored in the company’s stock price, which has corrected 28% from its 52-week highs. The big question now is whether the company’s 2015 guidance marks the bottom for the company. I believe the worst is already factored in the company’s updated guidance. Oil prices seem to be bottoming while the dollar is also stabilizing. Sell side analysts are expecting the company’s topline to remain flattish and its EPS to increase in FY2016.
In his recent research report, Deutsche Bank analyst Vishal Shah commented,
“Although investor expectations were low, the key question now is whether the new 2015 EPS guide marks the bottom or whether there are more shoes to drop. We believe the new guide appropriately reflects the macro/energy related risks in 2015 and while we acknowledge there are limited near term catalysts, with 2015 likely representing the earnings trough and given the relatively attractive dividend yield/buyback program, we maintain our Buy rating.”
Caterpillar is trading at a forward PE of 16.14 and has a forward annual dividend yield of 3.50%. I expect the company to be more aggressive in terms of buy backs and restructuring going forward. While I don’t expect fundamentals to improve significantly in the near term, the company’s medium to long term prospects are good. The recent correction is an opportunity for the long term investors to buy this quality large cap stock cheap.
