Free Annual Reports
Caterpillar Transforming Before Our Eyes
Global heavy equipment maker Caterpillar (NYSE:CAT) surpassed earnings expectations yet again on Wednesday, and once again notched estimates higher for the full year. The market's reaction, however was nothing like the applause (and subsequent stock bump) seen after the company's first quarter earnings, as investors are worried about softness in Western Europe that is being seen by Caterpillar and competitors like Terex (NYSE:TEX) and Dutch machinery maker CNH Global NV (NYSE:CNH).
With so much of individual stock activity tied to the broad market's turbulence these days, investors would be wise to look under the surface to see that Caterpillar is recording record earnings while its largest market is slouching toward a recession.
Metamorphosis from Cyclical Stock
It seems that Wall Street as a whole has yet to warm itself to the very plausible theory that Caterpillar is no longer a simple cyclical trade. Along with the "cyclical" status comes the unfortunate distinction of having your P/E driven into the low teens during times of "peak earnings". Since shares trade today at a current P/E of less than 13, it seems the market feels that right now is a period of "peak earnings". A simple question arises: In what part of the world is the economy peaking at this particular moment? (To learn more, read Cyclical Versus Non-Cyclical Stocks.)
Cat's flagship U.S. market - the one that used to make and break company fortunes - is in the toilet, pure and simple. Residential construction is sitting at once-in-a-generation lows by any measure, while commercial & retail construction is just beginning to show the visible scars of battle. Truck engine production is slow as well, thanks to record oil prices and stagnant GDP.
Even though there's been little to no growth in these businesses for several quarters, CAT is still pumping out record earnings each quarter thanks to boom-time periods for energy and mining.
Earnings Report Highlights
Net income came in at $1.74 per share, or $1.11 billion. This is a more than 30% increase year-over-year. Revenue was up 20% to $13.62 billion. Examining the results by region paints quite the succinct picture:
Once you look over these results, it's easy to see why international sales are now 60% of total revenue, up from 55% in 2007. The U.S. may still be the largest single market, but it isn't anywhere close to the umbilical cord it once represented to Caterpillar. And yes, there are concerns of overheated growth in regions like Asia and the Middle East, but the global infrastructure boom is something that takes decades to roll out, not years.
North American sales actually went up 7%, despite the woes described above. Relative strength was seen in sales to coal producers (which are seeing record spot prices for coal), while an increasing array of after-market services such as logistics, remanufacturing and rail/freight provide diverse sources of revenue for Caterpillar. It's not just backhoes and engines anymore.
Input Costs a Question Mark
CEO Jim Owens commented about the rising price of steel, a major factor in Caterpillar's supply chain. Both Cat and Terex feel that they can pass the majority of these costs on to their customers, but margins could feel the pressure if steel prices escalate further, or if energy prices continue to rise.
But many of these factors are already in place, and so far the company is doing a fantastic job maintaining margins. Operating margins for the machinery and engines segment were 11.2% in the second quarter, up from 10.6% a year ago.
Parting Thoughts
I'm trying to wrap my mind around the idea that the markets capitulated in the middle of this month; it had a lot of the supporting signs such as massive volatility and a crushing of the banks (the major culprit behind losses in the S&P 500's earnings over the past 12 months).
The bigger question remains: How long before the economy actually picks up in terms of GDP growth? One quarter, two quarters? Once investors get some visibility into this vital point, I think investors who consider CAT just a domestic play will be looking at the stock again. The international growth will still be there, and the stock could quickly become a darling once again. For the year, Caterpillar shares are down a shade under 4%, compared to a 14% drop in the SPDR Trust ETF (AMEX:SPY).
Also, investors shouldn't overlook what a special CEO Caterpillar has in Jim Owens. He possesses one of the keenest financial minds you're likely to find at any S&P company. His insights into the markets are widely followed, and he leads his company from a framework of truly understanding the global economy. Shareholders are lucky to have him.
Learn more about diversifying globally, in our related article Going International.
With so much of individual stock activity tied to the broad market's turbulence these days, investors would be wise to look under the surface to see that Caterpillar is recording record earnings while its largest market is slouching toward a recession.
Metamorphosis from Cyclical Stock
It seems that Wall Street as a whole has yet to warm itself to the very plausible theory that Caterpillar is no longer a simple cyclical trade. Along with the "cyclical" status comes the unfortunate distinction of having your P/E driven into the low teens during times of "peak earnings". Since shares trade today at a current P/E of less than 13, it seems the market feels that right now is a period of "peak earnings". A simple question arises: In what part of the world is the economy peaking at this particular moment? (To learn more, read Cyclical Versus Non-Cyclical Stocks.)
Cat's flagship U.S. market - the one that used to make and break company fortunes - is in the toilet, pure and simple. Residential construction is sitting at once-in-a-generation lows by any measure, while commercial & retail construction is just beginning to show the visible scars of battle. Truck engine production is slow as well, thanks to record oil prices and stagnant GDP.
Even though there's been little to no growth in these businesses for several quarters, CAT is still pumping out record earnings each quarter thanks to boom-time periods for energy and mining.
Earnings Report Highlights
Net income came in at $1.74 per share, or $1.11 billion. This is a more than 30% increase year-over-year. Revenue was up 20% to $13.62 billion. Examining the results by region paints quite the succinct picture:
|
Region |
Q2 Sales Growth |
Cumulative Sales Growth (\'06-\'08) |
|
North America |
7% |
-3% |
|
Asia/Pacific |
52% |
84% |
|
Latin America |
27% |
55% |
|
Europe, Africa, and Middle East |
22% |
60% |
Once you look over these results, it's easy to see why international sales are now 60% of total revenue, up from 55% in 2007. The U.S. may still be the largest single market, but it isn't anywhere close to the umbilical cord it once represented to Caterpillar. And yes, there are concerns of overheated growth in regions like Asia and the Middle East, but the global infrastructure boom is something that takes decades to roll out, not years.
Input Costs a Question Mark
CEO Jim Owens commented about the rising price of steel, a major factor in Caterpillar's supply chain. Both Cat and Terex feel that they can pass the majority of these costs on to their customers, but margins could feel the pressure if steel prices escalate further, or if energy prices continue to rise.
But many of these factors are already in place, and so far the company is doing a fantastic job maintaining margins. Operating margins for the machinery and engines segment were 11.2% in the second quarter, up from 10.6% a year ago.
Parting Thoughts
I'm trying to wrap my mind around the idea that the markets capitulated in the middle of this month; it had a lot of the supporting signs such as massive volatility and a crushing of the banks (the major culprit behind losses in the S&P 500's earnings over the past 12 months).
The bigger question remains: How long before the economy actually picks up in terms of GDP growth? One quarter, two quarters? Once investors get some visibility into this vital point, I think investors who consider CAT just a domestic play will be looking at the stock again. The international growth will still be there, and the stock could quickly become a darling once again. For the year, Caterpillar shares are down a shade under 4%, compared to a 14% drop in the SPDR Trust ETF (AMEX:SPY).
Also, investors shouldn't overlook what a special CEO Caterpillar has in Jim Owens. He possesses one of the keenest financial minds you're likely to find at any S&P company. His insights into the markets are widely followed, and he leads his company from a framework of truly understanding the global economy. Shareholders are lucky to have him.
Learn more about diversifying globally, in our related article Going International.
by
Ryan Barnes
Ryan Barnes has over 10 years experience in portfolio management and investment research, covering equities, fixed income and derivative products. Barnes has worked with Merrill Lynch, Charles Schwab, Morgan Stanley and many others as an institutional trader, and maintained AIMR compliant performance for a diverse set of high-net-worth investors.
Barnes is currently working as a writer and financial modeling consultant specializing in capital appreciation and hedging strategies, and is the editor of EpiphanyInvesting, a website devoted to finding long-term success in the stock market.
Barnes is currently working as a writer and financial modeling consultant specializing in capital appreciation and hedging strategies, and is the editor of EpiphanyInvesting, a website devoted to finding long-term success in the stock market.
Free Annual Reports
