Caterpillar (CAT, Financial) has been in the news lately. Assessing the operations of the industrial giant, a Dow Component with a $54 billion market capitalization, minus headline influence in any investment decision should be worthwhile.
Earnings performance
Caterpillar reported its fourth quarter and fiscal year results in late January. For 2016, the heavy construction equipment maker delivered 18% sales decline to $38.5 billion and $67 million loss compared to $2.5 billion gain in 2015.
Caterpillar recorded three large non-cash charges and higher than expected restructuring costs during the fourth quarter of 2016, which led to the recorded loss for the full year operations.
According to its results discussion, the three charges were: $985 million mark-to-market losses for remeasurement of pension and OPEB plans — primarily due to low interest rates, a $595 million goodwill impairment charge related to Caterpillar’s Surface Mining & Technology reporting unit, a $141 million state deferred tax valuation allowance and $1.09 billion restructuring costs related to Caterpillar’s Resource Industries and Energy & Transportation.
In total, Caterpillar recorded $2.6 billion in such expenses in 2016 vs. $1.08 billion in 2015.
In 2017, Caterpillar still expects another $500 million restructuring costs primarily related to ongoing manufacturing facility consolidations to lower our cost structure in response to weak economic conditions, according to filings.
“Our results for the fourth quarter, while slightly better than expected, continued to reflect pressure in many of our end markets from weak economic conditions around much of the world. Our team did a great job in the quarter, as they have all year, aligning our cost structure with current demand while preserving capacity for the future. I’m confident we are focusing on the right areas: controlling costs, maintaining a strong balance sheet and investing in the key areas important to our future," Caterpillar CEO Jim Umpleby said.
Outlook
For 2017, Caterpillar sees its sales to be with a midpoint of $37.5 billion — a 2.7% decline from 2016. The heavy equipment maker also sees a profit per share of $2.30 vs. losses of 11 cents cents a share in 2016.
“We continue to execute in a challenging economic environment and are focused on improving operating margins, profitability and shareholder returns. While we see signs of positive activity in some of our key end markets, the overall economic environment remains challenging," said Caterpillar CEO Jim Umpleby.
Valuations
With its given expected profit per share for fiscal 2017, Caterpillar with its current share price of $92.31 — at the time of this writing — would have a forward P/E ratio of 40 times vs. industry median of 23, according to GuruFocus data.
Caterpillar also trades at a hefty premium compared to its book value with a P/B ratio of 4.1 times vs. industry median 1.7. The company also had a P/S ratio of 1.4 times vs. industry median 1.2.
Caterpillar also had a trailing dividend yield of 3.31% while having provided $1.8 billion in total dividends despite having losses in 2016.
Total return
Caterpillar has outperformed the broader S&P 500 Index in the short-term. According to Morningstar data, Caterpillar had a one-year total return of 33.7% vs. S&P500's 21.8%. Over a five-year basis, the industrial company had provided -0.79% loss vs. the S&P 500's 14%.
Caterpillar
Caterpillar was originally organized as Caterpillar Tractor Co. in 1925 in California. Per its 2016 total sales, Caterpillar 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 - Construction Industries, Resource Industries and Energy & Transportation - and also provides financing and related services through its Financial Products segment. Caterpillar is also a leading U.S. exporter.
In 2016, Caterpillar generated 47% or $17.96 billion of its total sales from North America, 23% in EAME — could be Europe, Middle East, and Africa, followed by 21% from Asia/Pacific, and 9% from Latin America.
Currently, Caterpillar has six operating segments with four reportable segments.
Construction Industries
A segment primarily responsible for supporting customers using machinery in infrastructure, forestry, and building construction applications.
The segment’s product portfolio includes backhoe loaders, small wheel loaders, small track-type tractors, skid steer loaders, multi terrain loaders, mini excavators, compact wheel loaders, telehandlers, select work tools, small, medium and large track excavators, wheel excavators, medium wheel loaders, compact track loaders, medium track-type tractors, track-type loaders, motor graders, pipelayers, forestry products, paving products and related parts.
In 2016, construction industries sales fell by 12.3% to $15.6 billion or 41%* of total company sales. The segment delivered an operating margin of 11% vs. 10% in the prior year.
*excluding eliminations and adjustments in total company sales.
Resource Industries
Resource Industriesis primarily responsible for supporting customers using machinery in mining, quarry, waste and material handling applications.
The product portfolio includes large track-type tractors, large mining trucks, hard rock vehicles, longwall miners, electric rope shovels, draglines, hydraulic shovels, track and rotary drills, high wall miners, large wheel loaders, off-highway trucks, articulated trucks, wheel tractor scrapers, wheel dozers, landfill compactors, soil compactors, material handlers, continuous miners, scoops and haulers, hard rock continuous mining systems, select work tools, machinery components, electronics and control systems and related parts (1).
In 2016, Resource Industries sales fell by 26% to $5.73 billion or 15%* of total Caterpillar sales and delivered operating losses of $1.05 billion — worst among all segments — vs. $1 million profit in 2015.
Energy & Transportation
Energy & Transportation is primarily responsible for supporting customers using reciprocating engines, turbines, diesel-electric locomotives and related parts across industries serving power generation, industrial, oil and gas and transportation applications, including marine and rail-related businesses.
Energy & Transportation sales also fell by 22.2% to $14.4 billion representing 37%* of total company sales in fiscal 2016 with an operating margin of 15% vs. 18% in 2015.
Financial Products
Financial Products provides financing to customers and dealers for the purchase and lease of Cat and other equipment, as well as some financing for Caterpillar sales to dealers.
Financial Products sales fell by 3.5% to $3 billion or 7%* of total sales with operating margin of 23%—highest among the segments—vs. 27% the year prior.
All other operating segments
Primarily includes activities such as the business strategy, product management and development, and manufacturing of filters and fluids, undercarriage, tires and rims, ground engaging tools, fluid transfer products, precision seals and rubber, and sealing and connecting components primarily for Cat products (2).
Sales of all other operating segments fell by 31.5% to $139 million in fiscal 2016 and delivered $77 million losses vs $75 million in 2016.
Cash, debt and book value
As of December, Caterpillar had cash and short-term investments of $7.2 billion and $36.8 billion in debt with a debt-equity ratio of 2.78 times vs. 2.55 times in 2015. The company also had 11.2% of $74.7 billion assets in goodwill and intangibles. Also, Caterpillar had a book value of $13.2 billion compared to $14.9 billion in 2015.
Cash flow
In 2016, Caterpillar saw its cash flow from operating activities decline by 16% to $5.6 billion. In addition to its business operational losses, Caterpillar increase cash outflow in accrued wages, salaries and employee benefits and other liabilities — net on a year-on-year basis.
Capital expenditures including equipment leased to others were $2.93 billion leaving Caterpillar with $2.68 billion in free cash flow vs. $3.41 billion in 2015. As mentioned earlier, the company allocated 67% or $1.8 billion in dividends.
On average, Caterpillar allocated 101% of its free cash flow in dividends and share repurchases — which it halted the latter in 2016.
Caterpillar took in $899 million in asset disposals while it had a net cash inflow of $269 million after taking into account additions and collections in finance receivables, investments, and acquisitions, sales and investments in business and investments and securities.
Caterpillar also allocated $1.45 billion in debt repayments net any proceeds in fiscal 2016.
Conclusion
Brought by industry slowdown, Caterpillar’s business operations reflected steadily declining sales and eventual profit losses in recent years. In addition, the company still sees another moderately weak performance in its operations the coming year with another set of impairment to record.
As observed, free cash flow also has been on a gradual decline albeit the company had shown commitment in reducing its debt. Caterpillar also had been able to maintain its dividend payouts despite the ongoing hardship in its business.
Caterpillar reflected a bit more leveraged balance sheet compared to its previous year of operations.
Despite the recent operational performance and weak outlook, Barclays raised Caterpillar to overweight from equal weight and added $10 more to its price target to $110—representing a forward P/E ratio of 47.8 times more than twice the industry median’s average.
Meanwhile, Caterpillar had an average price target of $92.95 a share among the 21 analysts that cover the company.
Using a 30% margin with the company’s projected profit per share for fiscal 2017 and applying its five-year earnings multiple average gave a value of $22 a share — a 76% drop from today’s share price or a 10 times forward P/E ratio.
In summary, Caterpillar is an easy pass.
Notes
(1) 10-K
In addition to equipment, Resource Industries also develops and sells technology products and services to provide customers fleet management, equipment management analytics and autonomous machine capabilities. Resource Industries also manages areas that provide services to other parts of the company, including integrated manufacturing and research and development.
(2) 10-K
Continuation: parts distribution; distribution services responsible for dealer development and administration including a wholly-owned dealer in Japan, dealer portfolio management and ensuring the most efficient and effective distribution of machines, engines and parts; digital investments for new customer and dealer solutions that integrate data analytics with state-of-the art digital technologies while transforming the buying experience.
Disclosure: I do not have shares in any of the companies mentioned.
