Caterpillar (CAT) in a Rough Patch: Will It Turn Around?

On Sep 13, 2016, we issued an updated research report on the mining and equipment behemoth, Caterpillar Inc. CAT . Caterpillar has been struggling with weak mining, evident from its sales growth which remains in the red for an unprecedented 44 months. We believe relentless cost saving actions and improvement in construction are the only means for the company to stay afloat.

Caterpillar recently reported a 19% plunge in its global retail sales for the three-month period ending Jul 2016, close to the worst monthly performance of a decline of 21% witnessed in Feb 2016. After remaining stable at a drop of 12% in the prior three months, the sales graph has again taken a dip. So far this year, the monthly sales have posted an average fall of 14.8%.

Caterpillar's results continue to reflect tough market conditions for many of its businesses - mining, oil and gas, and rail. The second-quarter performance was no different as the company suffered a 22% plunge in earnings to $1.09 per share. It remains cautious for the second half of the year and does not expect an upturn in these markets.

Even though commodity prices seem to have stabilized, it still remains at low levels. Further, global uncertainty clouds the outlook given the surprising Brexit outcome and the turmoil in Turkey. Caterpillar now projects revenues in the $40-$40.5 billion range, as against the previous outlook of $40-$42 billion. It also anticipates earnings per share (excluding restructuring costs) of $3.55, down from the earlier projection of $3.70.

Further, at second-quarter end, Caterpillar's backlog was $11.8 billion, a $1.3 billion decline sequentially and down $3 billion year over year. This does not bode well for third-quarter performance.

In a separate development, Joy Global JOY will be acquired by Japanese mining and construction equipment maker and seller Komatsu Ltd. Komatsu will continue to offer its unrivaled Dantotsu products, services and solutions to its customers. In addition, the Joy Global buyout will add underground mining and super large-sized loading equipment for surface mining to Komatsu's existing portfolio. The combined company could, thus, pose a stiff challenge to Caterpillar.

In the wake of choppy end markets, Caterpillar's goal is to reduce costs, such that the decline in operating profit is no more than 25-30% of the decline in sales and revenues. The company has boosted its restructuring actions and has effectively reduced $1.1 billion in costs year to date and plans a target of over $2 billion for 2016. In line with this, Caterpillar recently announced it is contemplating allocation of the volumes produced at its facility in Gosselies, Belgium, to other manufacturing facilities to reduce manufacturing capacity and cut down operating costs in the wake of lower demand.

Caterpillar anticipates lower period costs that include period manufacturing, SG&A and R&D of in 2016. This is mainly due to substantial restructuring actions implemented near the end of 2015 and continuing in 2016.

Another ray of hope for the company is that construction-related activity is picking up. The Architecture Billings Index, which is considered a leading indicator of U.S. non-residential construction, has remained above 50 in recent months, signaling robust conditions ahead for the construction industry. Improvement in the construction sector will help to partially mitigate the impact of the soft mining sector.

Caterpillar repurchased approximately $2 billion of its common stock during 2015. No repurchases were made in the first half of 2016. The company ended the quarter with cash and short-term investments of $6.8 billion, while its debt-to-capital ratio at ME&T was 39%, within its targeted range of 30-45%. Further share repurchases will be accretive to earnings.

Caterpillar currently carries a Zacks Rank #3 (Hold).

Other Stocks to Consider

Other stocks in the sector worth considering are Astec Industries, Inc. ASTE and Deere & Co. DE . Both of these stocks sport a Zacks Rank #1 (Strong Buy). You can see the complete list of today's Zacks #1 Rank stocks here.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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