Shares of Caterpillar (NYSE: CAT ) may have zoomed 14% year to date, but whether there's room for more upside will be known later this week when the bellwether reports its first-quarter numbers, and guides into 2014.
It's a given that the construction market in the U.S. has sprung back on its feet -- Manitowoc (NYSE: MTW ) , which specializes in all-purpose cranes, received a better-than-expected response at the March ConExpo 2014, confirming the ongoing strength in the market. But will that be enough to propel Caterpillar forward when the mining industry is still in the doldrums, and Alcoa (NYSE: AA ) sounded the warning bell for some product markets that Caterpillar's highest-margin business caters to?
Here are five factors you should watch for in Caterpillar's upcoming report to judge where the company's headed.
The real profits
Analysts expect Caterpillar's first-quarter earnings per share to drop 6% year over year on flat revenue. While that shouldn't be surprising, you must also note that the company had plans to repurchase shares worth $1.7 billion in Q1. That's a substantial amount, which should have reduced the company's share count by a good number during the quarter, thus boosting its EPS.
Simply put, to get the real picture about how weak Caterpillar's earnings have gotten year over year, I'd advise you to strike out the impact of share repurchases.
Is the inventory-winding stage over?
You'll hear a good deal of discussion about inventory levels in every Caterpillar earnings report. That's because the company relies on its widespread dealership network for sales, so it has to factor in its own, as well as dealers' inventory levels before deciding on production schedules.
Caterpillar and its dealers reduced massive amounts of inventory last year. In other words, dealers ordered less, and the company lowered production, while aligning their existing inventory levels with demand.
If Caterpillar and its dealers continued to wind down substantial amounts of inventory during the first quarter, it means that demand from end markets, especially mining, continue to be very weak.
Furthermore, Caterpillar's production level should pick up this year if market conditions improve. If doesn't hint at such probability, consider it a yellow flag.
Are those markets growing?
The North American market may have turned stronger in recent months, but that won't help Caterpillar much as long as international markets don't pick up, because nearly 70% of its revenue comes from markets outside the U.S. That's also one reason why Manitowoc has outperformed Caterpillar (in operational terms) during the past few quarters. Manitowoc gets more than 50% of its sales from North America.
Caterpillar's total retail machine sales from the Asia-Pacific and Latin America regions fell 17% and 16%, respectively, during the three months through February. That weakness should reflect in Caterpillar's first-quarter revenue. Look for the company's outlook and plans for key global markets for the rest of the year in its upcoming earnings call.
One positive sign could be sales from China. You may be surprised to know that Caterpillar's revenue from the nation climbed 20% in 2013. If the trend continues into Q1, Caterpillar's fortunes could turn around sooner than expected. Alcoa recently sounded positive about China, so if Caterpillar resounds the optimism, it could signal better days ahead.
Is Caterpillar's largest business slowing down?
Caterpillar's energy and transportation (erstwhile power systems) business has hugely helped offset some of the weakness in its resource industries (mining equipment) business in recent quarters. But Alcoa gave a dour outlook for industrial gas turbines, which count among Caterpillar's key products. In fact, Caterpillar even reported 10% lower equipment sales from the oil and gas market for the three months ended February.
Look for potential signs of weakness in Caterpillar's upcoming earnings call. Slowdown in any of its end markets, such as marine, rail, power, or oil and gas, could hurt sales and margins of its energy and transportation business. And that could only push Caterpillar's turnaround a step further.
Take Caterpillar's outlook with a grain of salt
Caterpillar earlier projected to generate revenue in the range of plus or minus 5% of $56 billion this year, and earn $5.30 a share, including the impact of restructuring costs. While I think Caterpillar already took a conservative stand with its guidance, I'd also not want to forget that the company revised its 2013 guidance at least twice through the year.
With mining companies expected to scale back capital expenditures further this year, and key markets like China not showing much signs of improvement, I'd advise you to take Caterpillar's outlook with a grain of salt. Or simply, don't get too excited if the company sounds optimistic.
Caterpillar's earnings report is a lot more than just top- and bottom-line growth, so you should be well prepared. Oops, I forgot to mention: Don't miss what the company has to say about the ongoing investigations of its offshore tax practices. That's an added challenge Caterpillar needs to resolve soon.
Caterpillar may disappoint, so here are three great stock picks for you
You probably know by now how record oil and natural gas production is revolutionizing the United States' energy position. But did you know that you can reap big profits from the energy boom while saving on your taxes? Yes, it's possible. The Motley Fool has identified a small IRS "loophole" that supports your investments in some of America's greatest energy companies. To learn the strategy, and the names of the energy companies taking advantage, grab our special report, "The IRS Is Daring You to Make This Energy Investment" today. It's absolutely free -- so click here to access your report before the rest of the market catches on!