The Real Story Behind Caterpillar Inc.'s Big Sales Drop
Just when investors thought the worst was over for Caterpillar , the heavy-equipment company dropped a bomb last week by reporting, for the three months ended in April, the sharpest decline in four years in its retail machinery sales. Aside from its quarterly reports, Caterpillar releases supplementary information about its retail machinery sales every month for the preceding three months on a rolling basis.
Its latest monthly report left investors scratching their heads: Had they jumped the gun when the industry leader beat Street estimates for its first quarter? Should they have, instead, paid closer attention to Deere's and Manitowoc's relatively muted construction equipment sales numbers?
All right, I'm going to answer that question right away: yes... and no. No, because knowing that Caterpillar's sales fell 13% for past three months is half the story. Yes, because the sales report indicates deep trouble at its mining business, which doesn't bode well for the company and its investors.
The good and the ugly
Beginning with the good news, Manitowoc's Q1 crane sales may have slumped 14% year over year and Deere's construction equipment sales risen just about 2% in its last quarter, but Caterpillar investors need not worry. Its latest sales report just confirmed the ongoing strength in the construction markets.
Here's a break up of how Caterpillar's three business segments -- construction industries, resource industries (primarily mining), and energy and transportation (previously power systems) -- performed during the quarter ended April versus the comparable period last year.
Direction of Sales
% Change in Sales
Energy and Transportation
As evidenced in the table above, Caterpillar's construction equipment business had nothing to do with the 13% drop in the company's total sales for the past three months. That's great news, but wait -- that massive 49% drop in its resource industries segment sales should make you sit up.
Other businesses cannot pull Caterpillar out of the low-growth zone if mining equipment sales continue to fall at such rapid pace. And things haven't been as bad as they look now. Here's what Caterpillar said during its last earnings release about its mining equipment business: "Order rates are a fraction of where they were in 2011 and during the first half of 2012, and are substantially below where we believe the long-term sustainable level is."
That sounds ominous.
What's more, Caterpillar's full-year guidance of 20% lower sales from the resource industries division "reflects a drop of about 80 percent in sales of large mining trucks" compared to 2012. For perspective, Caterpillar generated $21 billion worth of revenue from its resource industries division in 2012, compared to only $13 billion last year. And the company is projecting another 20% drop this year. Ouch!
Why you need to worry
The real problem extends well beyond the top line. Analysts that have turned bullish about Caterpillar are betting on increased global construction activity, but do you know that construction equipment is traditionally the company's lowest margin business? Conversely, resource industries contributed most to Caterpillar's operating profits until tables turned last year.
As you can see, Caterpillar's resource industries division made up 40% of its M&PS operating profits despite contributing only 28% to sales in 2011. Conversely, construction industries had a much greater share in revenues but the lowest share in profits at 24%.
The figures for 2012 had a similar story to tell, with resource industries contributing a whopping 45% to Caterpillar's M&PS operating profits compared to construction industries' 19% share.
The pattern continued into 2013. Take a look:
This chart highlights another worrisome point -- construction industries contributed exactly as much to Caterpillar's M&PS sales last year as in 2011, but its share in profits slipped three percentage points to 21%, which was also the lowest among all divisions. Looks like the construction industries segment is under some pressure as well, which certainly isn't good news.
Long story short, the mining business is far more profitable to Caterpillar than construction equipment. The company sure did its own calculations, which is why it spent $8.6 billion to buy out mining-equipment maker Bucyrus International in 2011 in what was one of its biggest deals ever. Unfortunately, the commodities boom ended soon after.
So investors need to pause and think: How far can stronger construction markets take Caterpillar when there's so much at stake in the mining industry? Analysts may have turned bullish about the stock, but I don't see much upside until the mining industry recovers. And if you're wondering about Caterpillar's energy and transportation business, it sure is firing on all cylinders. The graphs above are proof.
But then, why does Caterpillar still expect to end 2014 with lower, or flat at best, revenue over last year despite expecting 10% and 5% higher sales, respectively, from its construction equipment and energy and transportation businesses? Yes, the mining malaise has pushed Caterpillar into a deep hole, and it will have to fight hard and long to crawl out of it.
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The article The Real Story Behind Caterpillar Inc.'s Big Sales Drop originally appeared on Fool.com.Neha Chamaria has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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