- The mining ETF is signaling that a bottom may have formed.
- Caterpillar's Cash flows fell again in 2015. Investors have to be mindful of pay-out ratios
- The longer commodities spend is in a bear market, the more facilities Caterpillar will be forced to close
It was more of the same from Caterpillar (NYSE:CAT) in its latest set of earnings although it did beat expectations on the earnings front. Revenue came in at $11 billion which was $430 million behind consensus and a whopping $3.2 billion less than the same quarter last year. Nevertheless, Adjusted EPS came in at $0.74 which was $0.05 ahead of general consensus and FY16 earnings guidance (EPS of $4.00) beat previous projections by some margin ($3.48).
This is why Caterpillar stock opened up $4 higher when the market opened on the 28th of January. Furthermore, what is impressive about FY16 guidance is that the company isn't factoring in any growth in the global economy in 2016. This means the company definitely seems to be making inroads on the costs side which is encouraging for long term investors.
In fact, Caterpillar is projecting that projected lower sales and revenues in 2016 will be more or less offset by costs savings in areas such as restructuring and pension and post employment benefits costs. Most of the heavy restructuring of costs was done in 2015 so costs should fall here and an accounting principle change regarding employee compensation is expected to net a further $425 million in savings.
These measures are excellent in that they buy the company time to weather the current commodity downturn. Nevertheless, it needs commodity prices (as it's a very high fixed cost company) in order to see any type of earnings growth in the future. Here are a few things to watch going forward if considering going long Caterpillar at this point.
Caterpillar's resource industries segment (mining) sales dropped by 23% to $1.83 billion in the fourth quarter but the mining sector has started 2016 very well (up 7%+ year to date and 12% in the last 10 days) and maybe just maybe an intermediate bottom has formed or is forming as we speak. If we look at a technical weekly chart, we can see that the weekly stochastic is nowhere near being overbought which means if the January 19 low can hold, the mining may have printed a final bear market bottom.
Capex budgets have been cut heavily in mining companies are saying this is hurting Caterpillar's sales. Furthermore, many miners have machines idle which means even if we see prices rise in commodities, Caterpillar's sales in this segment may not increase meaningfully in the near term. However, Caterpillar has reduced sales forecasts in this segment once again which may not come to pass if indeed we have printed a bottom in the mining complex. Watch the Gold bugs index. If these indices stay above their recent January lows whilst also break through their October highs, the mining sector could be initiating a new bull market run.
Dividend investors will have to keep an eye on cash flows if sales continue to slide as Caterpillar. ME&T operating cash flow fell to $5.2 billion in 2015 which was well down from the $7.5 billion printed in 2014. Furthermore equity has slipped to $14.885 billion meaning the current debt (all liabilities) to equity ratio has risen to 4.27%. Caterpillar returned $3.8 billion to shareholders in 2015 which comprised of $2 billion worth of share buybacks and $1.8 billion of common dividends.
These are big numbers which is why the company has to deliver on its cost cutting programs so the dividend can continue to be raised. Dividend growth rates have slowed slightly at Caterpillar recently despite its attractive 5%+ yield at present. Cash balance is also strong at $6.5 billion but rewarding shareholders by cutting costs also has its own ramifications.
What ramifications? Well 10,000 employees are predicted to eventually lose their jobs at Caterpillar (5,000 have left the company already since the announcement last September). Furthermore 9 facilities have now been either closed or consolidated and if the commodity bear market continues, I can only see more manufacturing facilities being closed.
This is the main dilemma facing Caterpillar, the dilemma of where exactly do they cut in the business. If too much cost cutting is done on core areas of the business, the company may not be able to take advantage of a recovery in the mining and energy sectors when they eventually come. Is the company doing enough on the investment front? Many investors believe that when the commodity cycle changes to bull mode, Caterpillar stock will outperform once again (as it did in 2009-2011 when the share price went up by a factor of five). However the longer this
However the longer this rout goes on, the worse it will be for Caterpillar because they will have to control manufacturing facilities which means astute investors would probably prefer to be invested in the commodity itself in case a short squeeze on the supply side ensued.
To sum up, Caterpillar is in one tough market but is doing all the right things to remain competitive. It still has a strong balance sheet and is still able to reward shareholders despite the big drops in its top line. However to avoid losing precious equity, the company needs to see a lift in commodity prices soon because a sustained slowdown would definitely decrease the company's market cap.