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Earnings Preview - Caterpillar Could Really Deliver (CAT)

Posted on | October 20, 2008 Time: 7:49 am |

The global construction, engine, & infrastructure giant reports earnings before the bell on Tuesday, and judging from the stock’s activity last week, investors are expecting a blowup. Caterpillar was one of the few industrial stocks unable to make a discernable bottom over the past 7 sessions, trading lower all the way into the close on Friday.

Current estimates call for Caterpillar to earn $1.50 EPS in the September quarter, and about the same in the 4th quarter. Full-year EPS of $6.00 was confirmed by management in the July conference call, and those estimates were based on downbeat view of the advanced economies:

...in terms of the outlook, we do see a weakening picture in North America, Western Europe and Japan and they are all included in our full year outlook”

One of the stated downside risks to the $6.00 target were rising input costs like steel, freight, and fuel. The recent crash of commodity prices should provide some benefit at the margin, although it will likely show through much more in the 4th quarter than the 3rd.

Downside, Tail Risks on the Surface

It goes without saying that new downside risks have appeared since waaayyy back in July; the most concerning to investors are the potential loan losses within the Cat Financial segment, which currently has over $22 billion in receivables loaded on the balance sheet. I think fears are overblown here, as Caterpillar only registered a net $19 million loss in the June quarter from writeoffs. This was up from $12 million in the first quarter, but still impressively low considering that past-due payments jumped to 3.35% in the 2nd quarter from 2.09% in the first.

Times like these are when the value of having a guy like Jim Owens running Caterpillar becomes massive. Not only has he been with the company for over 35 years, he has a Ph.D. in economics and a deep understanding of, and appreciation for, global economic and industry trends. While I’m not implying the guy hasn’t been caught off guard in the past month (who hasn’t?!?), his quarterly comments on global markets are as widely followed as any industrial CEO out there. If anyone could be considered prudent enough to navigate Cat’s distended financial operations, it should be Owens. Some final comments from him regarding the health of Cat Financial:

I remember most prominently the Asian crisis in ‘97 where, when we had a really cataclysmically negative situation across a lot of areas that Cat Financial had a lot of exposure, and we managed that at the end of the day with very little write offs. We had a lot of late payments and we moved a lot of product around, but keep in mind, again, we get good down payments. We know the customers. We know the product. When we have to repossess it, we can repossess it and remarket it. So that has been a real strength for Cat Financial, the highly integrated nature of how it works with our dealers and with the Caterpillar organization.

Upside Tailwinds?

There aren’t going to be many outright positives coming from the earnings report. Relative success will be in the guidance (will it hold?), Cat Financial results, and the trends in inventories and markets like the Middle East, Latin America, and Asia. The 2009 estimate currently calls for about $6.80 in earnings, or 13% growth from the 2008 target. I would expect some downward revisions here, but anywhere between $6.30 (5% YoY growth) and $6.60 (10%) for 2009 should be received well by the street. After all, that would put the forward P/E at less than 6.5, far below trough earnings levels seen in prior recessions:

Sales growth so far this year has been in the double digits with firm operating margins, a clear sign that the company is becoming less of a cyclical story and more of a secular one. The company’s bread & butter markets (U.S. construction, engines) have already been in a recession for over a year, and yet the company has still been hitting new sales & earnings records every quarter. Once the level of fear over Cat Financial is reduced, shares could have little resistance back to the low $50’s:

Disclosure: Author does not hold a position in CAT; shares held in EpiphanyInvesting Secular Trends Portfolio

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Read more on Caterpillar at Wikinvest
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