Why Investors Shouldn't Rejoice Over Caterpillar Inc.'s Earnings

Caterpillar's shares jumped after releasing fourth-quarter earnings, but investors would be wise not to get too carried away. Here's why.

Jan 30, 2014 at 7:59AM

It was a tough 2013, to say the least, for earth-moving-equipment maker Caterpillar (NYSE:CAT), which turned in one of the worst performances of the Dow Jones Industrial Average components. Understandably, investors who tuned in to the company's fourth-quarter and full-year report anxiously awaited any positive news they could get their hands on.

Expectations were low, meaning that Caterpillar had a relatively low bar to cross. While there are signs of progress, Caterpillar is still struggling in some of its key segments. Here are a few key items from Caterpillar's latest round of earnings for investors to focus on.

Cost cuts drive fourth-quarter-profit growth
Caterpillar's fourth-quarter earnings followed a familiar theme this earnings season, which is to produce profit growth through cost cuts and not sales growth. In all, Caterpillar's sales fell 10% in the fourth quarter and 16% for the full year. The company attributed its falling sales to reduced sales of its mining equipment.

Sluggish global demand for heavy machinery has hit Deere & Company (NYSE:DE) recently as well. Its own net sales dropped 3% in the fourth quarter. However, Deere navigated last year better than Caterpillar, since its worldwide sales increased 5% for the full year.

Caterpillar did manage to produce 48% earnings-per-share growth in the fourth quarter, but that was mostly due to cost cuts and an easy comparison from the prior year's fourth quarter. Caterpillar's fourth quarter 2012 earnings were negatively affected by a $580 million goodwill charge and positively affected by a $300 million tax settlement.

Stripping out these one-time items to focus on the company's core profitability paints a slightly different picture than the headline growth figure suggests. Caterpillar's adjusted earnings increased just 5% in the fourth quarter. For the full year, earnings per share actually declined by 32%.

And yet, shares of Caterpillar jumped on the day it released earnings. Caterpillar stock rose nearly 6% immediately after the opening bell. Optimism was likely fueled by the fact that Caterpillar's results were better than the market suspected, and the company was also aided by a 2014 outlook that wasn't as bad as many analysts feared.

Future outlook gives investors hope
Caterpillar management laid out a forecast for 2014 that looks fairly unimpressive, but the market nevertheless seemed pleased given the stock's performance. Sales are expected to be flat in 2014 versus 2013, plus or minus 5%. Earnings per share should clock in at $5.85 per share excluding some considerable restructuring costs estimated to shave $0.55 per share off earnings. Even without including these costs, Caterpillar's guidance calls for just 1.7% earnings growth in 2014.

In this regard, it's not clear that investors should be too quick to rejoice. Cost cuts aren't a long-term solution, which explains why Caterpillar is forecasting another difficult year ahead. Cutting expenses can only go so far and is a short-term fix. Investors should be concerned about the company's fairly steep revenue drop in the last year, as it's clear the downturn in global mining activity is taking a toll.

Whether that reverses over the next few quarters is far from a guarantee. Precious metals prices remain low, and other equipment makers that focus on the mining industry don't have many good things to say. Mining equipment giant Joy Global, (NYSE:JOY) reported its bookings fell 19% in its fourth quarter. Metrics deteriorated across the board in Joy Global's fourth quarter: sales fell 26%, and adjusted earnings per share collapsed by nearly half versus the same quarter the previous year.

The Foolish takeaway
It seems as though Caterpillar is being rewarded for an earnings report that was not outright awful. There's considerable weakness in Caterpillar's mining segment which is not expected to subside in the near term. On a positive note, Caterpillar is able to keep earnings afloat with aggressive cost cuts. And, the company announced a new $10 billion share buyback plan through 2018, which will further boost profits.

Investors should be careful not to get too carried away with Caterpillar's latest results. The market may be setting itself up for disappointment, given Caterpillar's persisting struggles.

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Bob Ciura 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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