Caterpillar Can Beat First Quarter Earnings Expectations

  • Caterpillar first quarter analyst estimates revised downwards by around $0.3. It has a good chance to beat on earnings and revenue.
  • Guidance for gross margin and sales will be key metrics to watch out for when the company announces results.
  • Cash flow is critical to dividend investors. Debt needs to remain stable in case the commodity complex has one more sharp move down.

Caterpillar (NYSE:CAT) is expected to announce earnings on the 22nd of April for its first fiscal quarter and the consensus EPS forecast is around $0.69 per share on revenue of $9.4 billion. Zacks is actually predicting $0.67 a share which highlights the problems in getting predictions as accurate as possible.

In fact, it was reported that Caterpillar reduced its Q1 guidance a few weeks ago by around $0.30 a share but the company's annual guidance remained the same which is a big boost in my opinion especially considering the guidance cut last year. However, Caterpillar never gave guidance for Q1 and the "cut" the media reported on was on analysts predictions and not what the company was guiding for.  All that happened here was that analysts mistakenly tried to divide up Caterpillar's annual guidance into the four quarters but they got Q1 horribly wrong. The intervention by Caterpillar means that now we have a strong possibility that the company reports a beat on its first quarter earnings on the 22nd of April.

In the first quarter of 2015, the equipment manufacturer reported an EPS of $1.86 on a turnover of $12.7 billion. The last 12 months alone illustrate the huge cyclical problems this company is going through at present but there has been a glimmer of hope recently for shareholders in that sharp rallies in the mining sector and energy have bolstered Caterpillar's share price. Now a rising share price doesn't necessarily mean that the fundamentals are improving here as we are still dealing with a company with negative top and bottom line growth.

In fact, the company printed a negative EPS last quarter which would have long-term investors definitely worried, especially regarding the sustainability of the dividend. In fact, the company just announced when it will pay its latest quarterly dividend of $0.77 which means that this pay-out should be the last one at this rate before it gets hiked again in the Summer. So in terms of stability, this first fiscal quarter is vital. Have the recent sharp rallies in commodities helped Caterpillar's forward-looking fundamentals? The market obviously thinks so. Here is what to look out for when the company reports.

Firstly, with rising commodity prices, Caterpillar seems to have all the ingredients in place to increase its sales in its energy and construction divisions. Why? Well apart from contractors needing to replace equipment, Caterpillar has actually increased its market share every year for the past 5 years which is bullish for the stock. Furthermore even though commodity prices have been depressed over the last few years, activity has remained buoyant as many companies have had no other choice but to keep operations going for cash flow purposes.

What does this mean to us investors? Well now that we are in a different environment, activity should only increase which should mean companies will have to invest in new machinery. Therefore, what to watch for in the earnings call will not necessarily be Q1 machinery sales but activity in terms of guidance or projecting for the following quarters. Furthermore, if annual guidance of $4.00 is amended upwards, the market would have another reason to value this stock higher.

The next item I would monitor would be margin levels - specifically gross margin levels which have remained buoyant despite the slump the company has suffered in sales (see chart). Rising sales along with rising profit margins would inevitably lead to rising earnings. Furthermore, what must be remembered here is that not only has Caterpillar become more efficient as a result of its recent changes in its manufacturing, administrative and R&D, its suppliers have also had to trim down expenses, which is why I believe margins will continue to expand going forward. Caterpillar reported gross margins of 28.23% last year. If this figure is met or beaten in the first quarter, it would be a sign again that better times are ahead for Caterpillar


Finally, astute dividend investors will be watching debt and cash flow levels in order to be able to gauge dividend growth levels going forward. Contrary to popular belief, Caterpillar's debt position is stable because over 70% of its obligations is actually to "Cat Financial" which is the company's financial wing. This debt is secured by the inventory it has sold against it. In fact, Caterpillar's present debt to equity ratio is 1.7 which is much lower than its 10 year average. Caterpillar likes to report its financial leverage by using the debt to total capital ratio ( debt/debt+equity) which present is 39.1%. The company has been very careful not to see this figure rise to ensure dividend investors continue to invest in this stock. If debt remains in check, I don't foresee cash flow becoming a problem.

To sum up, I believe Caterpillar has a good opportunity in beating its first quarter earnings guidance for 2016. I expect volatility in the stock to be minimal. Investors will be watching for top line trends (or guidance on future trends), profit margins and debt and cash flow levels to get an insight where the stock will be trading in 3 to 6 months time.

Jack Foley Jack Foley   on Amigobulls :
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  • I do not have any business relationship with the companies mentioned in this post.
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