Caterpillar soars on strong construction sales, raising long-term hopes

Fourth quarter earnings could be the catalyst Caterpillar needs to dig itself out of a financial hole.
Jackie Zimmermann/MEDILL

After being named one of the worst stocks in 2013, Caterpillar Inc.’s blow-out fourth-quarter earnings report is helping the company brush off the dust of a financially frustrating year.

Shares of the Peoria-based manufacturer surged 6 percent after cost cuts and stronger demand for construction equipment helped the company exceed analysts’ profit expectations for the fourth quarter.

“Essentially, Caterpillar hit every metric that was hoped for,” Lawrence De Maria, an analyst with William Blair, said in a research note.

After focusing on cost-cutting strategies during 2013, the company said it was able to reduce the impact of its underperforming mining sector, which “turned out to be worse than we anticipated.”

Additionally, the company’s construction operating margin was nearly double the analysts’ estimates.

The Peoria-based manufacturing giant reported earnings of $1.54 per share, or $1 billion in the final quarter of 2014, well above the $1.28 expected by analysts surveyed by Bloomberg L.P.

However, Caterpillar reported $14.4 billion in revenue for the fourth quarter, down 11 percent from $16.1 billion in the year-ago period.

While anticipating being plagued by weak sales in mining equipment and resources in 2014, Caterpillar expects its power systems and construction sectors to lead a modest 5 percent growth in sales.

“I think the company’s exposure to construction machinery is definitely a positive factor for CAT that warrants holding on to shares,” said Matt Arnold, equity analyst at Edward Jones. “Ultimately, the rating on the stock comes down to valuation, and we think the current valuation warrants holding for modest upside, along with the 2.7 percent dividend yield.”

Despite its financial woes in 2013, Caterpillar remains financially sound and offers investors a return on equity of 19.35 percent, higher than the industry average of 16.9 percent. A 14 percent drop in inventory since 2011 has generated a cash cushion significantly higher than it has been in the past.

“The company is focused on taking inventory out of the system at both the corporate and dealer level,” Arnold said. “Within the next couple quarters, this reduction should be complete and shipments to dealers at that point will likely track with shipments to end users.”

“If optimism turns up, dealer restocking could be a positive catalyst for CAT,” he said. “We would expect construction machinery demand to be much stronger than mining machinery demand for the foreseeable future, though.”

Investors looking to capitalize on Caterpillar’s international presence should view the company as a long-term investment.

“The international expansion should provide long-term growth opportunities, but fluctuations in these emerging economies could negatively impact near-term results,” Arnold said in a research note released after the company’s earnings.

In particular, the excavator market in China may help bolster Caterpillar’s long-term growth. Excavator sales increased 21 percent year-over-year in December, marking the third straight month of more than 20 percent growth. Additionally, the company’s market share increased 12 percent in the country.

In a research note by Zacks Investment Research, “the Chinese excavator market is expected to grow, and Caterpillar can capitalize on the demand, given its expanding market.”

Slight upticks in the commodities market may help the company dig itself out of its financial hole.

“At some point, the mining spending cycle will turn back positive, and CAT will have more leverage to the up cycle than it did in the past,” Arnold said. “In the meantime, the company has to focus on controlling costs, which it has a very good track record of doing.”

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