Although we don't believe in timing the market or panicking over market movements, we do like to keep an eye on big changes -- just in case they're material to our investing thesis.
What: Caterpillar (NYSE:CAT) shares soared 10% last week to hit price levels not seen in nearly 11 months after the construction equipment maker beat Street estimates on fourth-quarter numbers as well as guidance for 2014.
So what: Caterpillar stock was among the worst Dow performers in 2013. With investors getting impatient and analysts setting the bar low, any bit of positive news was bound to fire the stock. Otherwise, Caterpillar's numbers weren't the kind that should excite the market.
The company's fourth-quarter revenue slipped 10% while earnings per share jumped 48% year over year. But it boiled down to an insignificant $0.08-per-share improvement in earnings if you backed out one-time items from last year's quarter. Caterpillar projects 2014 revenue to be within 5% range of $56 billion and earnings to improve $0.10 per share. Again, that's encouraging only as long as you don't factor in the potential impact of restructuring costs on the bottom line. Caterpillar shut down some plants and is reducing head count as key end markets like mining continue to remains sluggish. Those additional costs could dent its 2014 earnings by at least $0.55 per share.
Now what: Caterpillar expects sales from its construction equipment and power systems (which sells gas engines, turbines, and rail locomotives) businesses to improve 5% each in 2014. Investors may have found that inspiring, but they should also note that revenue from Caterpillar's resource industries (mining) division is projected to drop 10% this year. That could wipe out any strength in other businesses, as well as shrink Caterpillar's margins since mining equipment traditionally generated the highest profits for the company.
In short, Caterpillar will continue to struggle until the mining industry recovers. And how long that will take is anyone's guess. Meanwhile, China's economy is still battling a slowdown, and other important markets, such as India and Brazil, are also losing steam. None of it bodes well for Caterpillar, which has considerable exposure to international markets. Headwinds are aplenty, and catalysts few.
The good news is that Caterpillar is turning this downturn into an opportunity to become leaner and financially stronger. That initiative, combined with its solid brand image, leadership position in the industry, and strong global presence should position Caterpillar well to lead the recovery as and when it happens. But for now, I think upside in the stock is limited and downside risk is higher after last week's rally. It could turn out to be a volatile year for Caterpillar investors.
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Neha Chamaria has no position in any stocks mentioned, and neither does The Motley Fool. 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.