It wasn't as though Caterpillar's (NYSE:CAT) earnings were ignored last week. When you're a Dow stock you don't get ignored, but I wanted to see a few other companies report before I chipped in my own commentary. After all, companies like Freeport-McMoRan (NYSE:FCX), Companhia Vale do Rio Doce (CVRD) (NYSE:RIO), ABB (NYSE:ABB) and Bucyrus (Nasdaq:BUCY) play into the analysis as well, either as competitors, customers or co-travelers. (For more talk about Dow companies, check out Barking Up The Dogs Of The Dow Tree.)
What's the story? Well, don't hold your breath waiting for Caterpillar to turn into a butterfly. The long-term global infrastructure and commodity stories will continue to play out for years, but they're likely to take a nap for the next year or so.
If you like companies that respect their shareholders by providing a wealth of details about financial performance and management outlook, you will like Caterpillar. Unfortunately, the details weren't all that great this time around.
Total revenue was up about 13% (with 13% growth in machinery and 16% growth in engines), but gross margins weakened a bit and operating profits fell 11% from last year's level. Volume and pricing were pretty solid (with exceptional volume growth in Latin America and Asia-Pacific), but the company gave that back on the cost side.
What Does The Future Hold?
Management laid out three primary issues facing Caterpillar - the impact of the credit crunch on end markets, how the company is positioned for the impending decline in activity and how it will be positioned for the eventual recovery. To these ends, the company does not yet appear terribly constrained by the credit freeze, and management is cautiously optimistic about a housing recovery starting in late 2009. Nevertheless, the company's finance business is seeing higher account delinquency, with this quarter at 3.64%. That's above last year's 2.52% level but still below the peak of 4.78% in the last recession.
Given that a meaningful portion of the company's revenue comes from commodities, the price of goods like copper, iron and coal aren't trivial concerns. Here is where I part company a bit from management. Caterpillar management mentioned that commodity prices today are still higher than when the boom began a few years back.
That's true, but it's only part of the story - it overlooks the increase in production costs since then and the fact that some commodities (like zinc, nickel and aluminum) are below the marginal production cost for many producers. When companies like CVRD, Alcoa (NYSE:AA) and HudBay are closing mines, delaying new production starts and otherwise curtailing production, that's not exactly good news for mining equipment makers like Caterpillar, Joy Global (Nasdaq:JOYG) or Terex (NYSE:TEX). (For more reading about commodities, don't miss Commmodity Prices And Currency Movements.)
Stop Me If You've Heard This Before
CAT shares are down more than 55% this year (as of the October 24 close), and trading is at the lowest valuations in well over 10 years. The company has the liquidity it needs to operate, emerging markets continue to grow and I'm more than willing to bet that the commodity super cycle will resume again after this credit market wash-out and recession.
What Does That Mean You Should Do?
Well, a lot depends on your personal pain threshold. Caterpillar is a solid company, and the combination of a housing boom and commodity boom allowed for solid double-digit returns on capital. All of that said, plenty of fish are in the value sea these days, so take advantage of the terrible market to do your due diligence and make your selections carefully.