3 Reasons Caterpillar Inc. Shares Could Get Crushed After Earnings Are Reported

Shares of Caterpillar (NYSE: CAT  ) have stayed in the green so far this year, but the upcoming week could reverse the gear. The heavy-machinery bellwether is set to report its fourth-quarter numbers Monday, and the Street has little to expect.

While close competitor John Deere (NYSE: DE  ) is optimistic about the construction equipment market and projects 10% sales growth for 2014, a sluggish mining industry -- as evidenced by a 19% fall in mining equipment specialist Joy Global's (NYSE: JOY  ) Q4 bookings -- could eat into Caterpillar's growth. Aluminum giant Alcoa's (NYSE: AA  ) recently announced dismal numbers (and flat demand projections for the metal in 2014) only exacerbate the situation.

So is Caterpillar certain to disappoint next week, or can you expect some probable positive signs in the upcoming report that could finally signal a turnaround for the company? You'll know better once you read this.

Brace yourself for some bad news
Analysts expect Caterpillar's fourth-quarter profit to fall 12% year on year on 15% lower revenue, but I wouldn't be surprised if the numbers look worse when the company reports.

Keep an eye on where Caterpillar's sales from North America are headed. When it reported small growth in its machine sales from the market during the third calendar quarter last year after months of decline, the market thought that the worst was probably over. Unfortunately, as per Caterpillar's last-announced statistics, North American machinery sales fell 2% over the three months ended November. That's bound to hurt Caterpillar's fourth-quarter top and bottom lines. Joy Global too witnessed a massive 33.5% slump in sales from the U.S. during its fourth quarter.

The real concern
Worse yet, Caterpillar's machinery sales from the Asia-Pacific, Latin American, and Europe, Africa, and Middle East regions dropped 24%, 8%, and 16%, respectively, during the three months ended November. That's a terrible set of numbers, and suggests that any growth in the U.S. market this year, backed by a housing recovery as Deere projects, will not be enough to propel Caterpillar forward if global markets start losing steam.

Weakness in the Asia-Pacific region is, perhaps, the biggest concern for Caterpillar right now, given that a major chunk of its investments are directed toward markets like China. Alcoa projects the commercial construction market in China to grow during 2014 at a pace slower than last year's, which bodes ill for Caterpillar. As for the Chinese mining market, Joy Global projects a bottoming, and even an uptick, during the latter half of the year.

Potential bullish signal?
Investors should particularly watch for Caterpillar's inventory level during its upcoming earnings call. Since Caterpillar primarily sells through dealers, unlike Joy Global which caters directly to end markets, it has to wait for dealers' inventories to wind down before it can benefit from any recovery in demand.

After its dealers took down inventories worth $800 million during the third quarter, Caterpillar expects another "substantial decline" during Q4. If the company hints at things normalizing at its dealers' end in the upcoming call, investors should consider it a positive sign.

Two key metrics to watch for
More importantly, investors should make sure they do not miss two key figures in Caterpillar's upcoming report:

  • sales growth in its power systems business
  • backlog value

Caterpillar's power systems business has been the most resilient in these challenging times, and has played a key role in boosting its revenue and operating profit. But things may be cooling down, as evidenced by the 5% fall in power systems sales during the quarter through November. If this business also slows down, Caterpillar could be headed for a rough ride in the near future.

Likewise, a growing backlog value could signal a turnaround as it indicates future potential revenue for a company. While Caterpillar didn't give a number, its order backlog during the third quarter "declined significantly" year over year and remained sequentially flat. If the trend continues into the fourth quarter, investors may have to wait longer to see the company's sales revive.

The Foolish bottom line
Caterpillar expects to report a profit of $5.50 per share for 2013, which represents a massive 35% decline versus 2012. That's not all -- it last projected a flat to 5% fall in revenue for 2014. While reiteration of the guidance next week will be bad, a lower outlook will be worse.

For a company that operates in a cyclical industry, one or two quarters may mean little, but dwindling sales from global markets, slumps in orders, and tepid guidance could indicate longer-term pain, and send Caterpillar shares lower. Pay heed to how Caterpillar expects the year to unfold and how it plans to tackle the headwinds while they last. Stay tuned for post-earnings updates next week.

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