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Caterpillar's Inventory Problem

In the following video, Motley Fool industrials analysts Brendan Byrnes and Blake Bos discuss some of Caterpillar's recent inventory troubles, and whether they are expected to continue. Caterpillar is the market share leader in an industry in which size matters, and its quality products, extensive service network, and unparalleled brand strength combine to give it solid competitive advantages. Read all about Caterpillar's strengths and weaknesses in our brand new report. Just click here to access it now.

Blake Bos: Hello, this is Blake Bos with The Motley Fool. I'm here today with Brendan Byrnes. We're going to be talking a little bit about Caterpillar (NYSE: CAT  ) , recent earnings. The company had a pretty exciting 2012. We had the scandal come about with the inventory, and ... what was the name of that?

Brendan Byrnes: It was the ERA Mining subsidy.

Blake: The ERA Mining subsidy; that was a little disconcerting to investors, and you saw earnings come out recently. I wanted to get some commentary from you. We've seen the inventory issues come up repeatedly.

Did they overbuild in China? What are your takeaways on inventory at Caterpillar?

Brendan: Certainly, a little bit. We did see the pull back in China, so that's definitely not good news there. Caterpillar did have to sell some inventory.

That's one of the reasons that we didn't see such a great quarter in the fourth quarter, but we were expecting that, to some extent, and I think it does set them up a little bit better for the future, kind of pulling off the Band-Aid a little bit in the fourth quarter.

I do think there are still some inventory issues that will work themselves out, going forward. Investors should definitely watch that, and one thing that really bears watching is Caterpillar's Resources segment. It's about 80% mining, it's where they realize by far their highest margins.

This segment, actually, dramatic slowdown in new orders versus 2011, when we look at the fourth quarter. They were getting by on orders that had already been booked. Something you need to watch, going forward, what's the mining demand in China? They're heavily vulnerable to commodity prices there, so that's definitely something to watch.

Does the mining boom kick back up in China? Countries like Australia, definitely something to keep an eye on if you're a Caterpillar investor. I do think the construction industry segment can help pick up a lot of the slack here as the U.S. housing recovery picks up even more steam going into 2013, but at the end of the day when you look at Caterpillar this remains a company incredibly highly levered to the global economy.

As the global economy goes, Caterpillar goes, and that's why when we see the earnings per share range for 2013, all the way from $7 per share to $9 per share ...

Blake: Yeah, it was pretty wide.

Brendan: That's an incredibly wide range, and that's pretty much useless, as an investor. The only thing that really tells you is the fact that this company is incredibly uncertain about the global economy, and that the dramatic effect that the global economy has on this company, on their revenues, all the way down to the bottom line, which obviously trickles into the share price.

Something to keep an eye on for Caterpillar investors, I think you watch three things, specifically coming up in 2013. As we mentioned, of course, you watch the global economy. They're highly levered to that.

You watch the resources industries segment, and relatedly the kick-up, potentially, in mining in China; I think we're heading for maybe a rough one to two quarters early in 2013 in the resources segment.

Number three, you watch if construction industries can come in and pick up the slack based on strong demand from the United States.

Three things to watch for Caterpillar, trading again at 10 times earnings. I'm a shareholder in this company. I bought down in the '80s. I still think it's an attractive bet, even up toward $100 per share they continue to set record profits, year over year.

They're going to have a tough 2013, but I think that's the reason this stock is held back in the 10X multiple range. I think it's pretty compelling for a long-term investor that can deal with short-term volatility because of the global economy.

Blake: Like you said, uncertainty usually provides for great opportunities to get into companies on the cheap, so it sounds like you think Caterpillar's earnings will increase after they get through these inventory issues and the global economy rebounds, but investors will need to have a really long time horizon.

Brendan: A long time horizon. It could be a rough 2013, but I'm bullish for this company overall. I think it's got a lot of great growth drivers, long term.

Blake: Yeah. It could be a good total return, with that nice dividend they pay as well.

Brendan: Sure.

Blake: All right, Brendan. Thanks for those comments on Caterpillar, and some great analysis. I encourage everybody to get on We have some great tools on there. I believe we have a Caterpillar ticker report, for example, that has some great takeaways.

Thanks for watching, and Fool on!

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5/27/2016 4:00 PM
CAT $71.96 Down -0.12 -0.17%
Caterpillar, Inc. CAPS Rating: ***