Image: Cat Financial.
Heavy-equipment maker Caterpillar is well-known for its trademark yellow machinery, which you'll find at construction sites across the world. Yet Caterpillar has been stuck in a cyclical downturn for years, with sluggish activity in construction, mining, and most recently energy sending its revenue and profits plunging. One area of Caterpillar's operations has held up better than the rest, and many investors probably don't even realize that this division of the company even exists. Let's look closely at Caterpillar's financial products segment to see how it has withstood the brunt of the economic downturn.
Helping customers buy products
Caterpillar's financial products division has a different mission from the rest of the company. Whereas most of Caterpillar's efforts go toward manufacturing its heavy equipment, Caterpillar Financial is a separate subsidiary from the primary Caterpillar entity. Its goal is to offer a wide range of financial solutions to prospective customers, as well as the dealer networks that help Caterpillar sell much of its equipment. In addition to its popular machinery, Caterpillar offers financing options on its engines, Solar gas turbines, marine vessels, and other types of equipment.
Caterpillar Financial offers options that regular sources of financing typically won't match. The working capital loans, revolving lines of credit, and operating leases that Caterpillar offers are similar to what you'll find from a host of other heavy-equipment operators, including Deere 's John Deere Financial. But customers can also get protection beyond a standard warranty for Caterpillar equipment, as well as equipment protection plans and physical damage insurance.
Perhaps most importantly, Caterpillar offers options that allow customers to upgrade their equipment without the hassles of having to figure out what to do with their outdated products. Caterpillar Financial offers end-of-term solutions that include outright purchases of leased equipment, refinancing of existing loans, and return of equipment back to Caterpillar Financial. In addition, Caterpillar maintains a website offering used equipment at cheaper price points than its new products, and that enables Caterpillar Financial to structure deals in whatever way can generate a sale.
How Caterpillar Financial has fared in 2015
Through 2015, the performance of Caterpillar Financial has helped provide some stability to the big declines in revenue that the rest of the business has seen. During the first quarter, Caterpillar's primary product division saw sales fall 4%, but the financial products division saw only a 1% drop in revenue. The advantages became even clearer later in the year, as Cat Financial posted a 3% revenue decline in the second quarter compared to a 14% drop in sales for the remainder of the business.
Cat Financial hasn't been entirely invulnerable to the company's slump. In the third quarter, financial products revenue fell 14%, compared to the 19% drop in Caterpillar's overall sales. The company said that its financing rates fell during the quarter, and the decline in business has led to a smaller base of assets from which the financial division can earn profits. Nevertheless, company executives have been pleased with its performance, with CEO Doug Oberhelman saying at Caterpillar's most recent quarterly conference call, "Key metrics are in line with long-term averages despite weakness in a few very critical markets, and it's healthy, well-managed, and risk is very much under control."
Can Cat Financial lead Caterpillar higher?
Investors shouldn't expect too much from Caterpillar's financial products business. The division produces less than 10% of Caterpillar's total revenue, and so favorable trends for the business don't have a huge impact on the top line for the company overall.
More importantly, financing alone won't help Caterpillar's product sales bounce back. Many of Caterpillar's customers are in a position where they can't afford to take on any new financial obligations even if they don't involve a cash outlay, as additional debt would further hamper their ability to tap credit markets for more important financial needs. As long as customers give lower priority to equipment purchases, Caterpillar will struggle.
Nevertheless, in the long run, Cat Financial will play a vital role in Caterpillar's recovery once the cyclical downturns in its key industries start to reverse. When the crisis ends, customers will need new equipment in a hurry. Caterpillar can rely on its financial products division to help those customers get the products they want and thereby boost the company's overall revenue. That's something every Caterpillar shareholder can get behind.
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The article Caterpillar Inc.'s Best Segment in 2015 originally appeared on Fool.com.
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