Caterpillar Inc.'s Stock Drops After Q2 Earnings: Is There a Bright Side?

To say that Caterpillar's (NYSE: CAT  ) sales and revenue struggled during 2012 and 2013 would be a severe understatement. The heavy equipment manufacturer remains heavily tied to overseas mining markets and demand for its heavy machinery was so weak the company might as well have used its colossal machines as play toys, because no customers were using them for business.

Unfortunately, it appears this year, as anticipated, will be just as flat on the top line as 2013 was. However, that doesn't mean all is lost for investors -- Caterpillar's second quarter did have some positive takeaways. Here are the highlights, both good and bad, and what to expect during the back half of 2014.

By the numbers
Caterpillar recorded net earnings per share of $1.57 during the second quarter, up 8% from last year's $1.45 per share. This year's second quarter also included a negative impact of $0.12 earnings per share for restructuring activities; without that in the calculation earnings per share could have reached $1.69 -- but hey, that's just business. 

The majority of Caterpillar's revenues and profits come from its machinery and energy transportation, or M&ET, business segment, the rest comes from its financial division. Within M&ET are three business segments: construction industries, resource industries, and energy and transportation.

One thing investors were curious about, heading into the second-quarter conference call, was if the severe plunge in revenue and profitability in its resource industries would outweigh top and bottom line progress in the other two segments.

While it appeared Caterpillar's energy and transportation sales slowed in the previous two months, the segment managed to produce a record quarterly profit. Meanwhile, construction industries posted an 11% increase in sales and an 83% improvement in profits, compared to last year's second quarter. Despite the improvements, however, you can see below that resource industries' horrendous performance continued to drag Caterpillar's M&ET consolidated operating profits lower.


Chart by author. Information source: Caterpillar's Q2 earnings release.

For a longer viewpoint, you can see how resource industries has gone from Caterpillar's most profitable segment to its least profitable.


Chart by author. Information source: Caterpillar's SEC filings.

Bright side?
It's tough to say there's much bright side for Caterpillar in the short term; though, it is a positive development that two of its three business segments are improving and that resource industries isn't continuing to plunge sequentially.

Caterpillar has focused on cutting costs to help salvage its bottom line, and it has paid off to some degree. Management was able to reduce year-to-date manufacturing costs, SG&A, and R&D expenses by nearly $500 million.

Also, despite the overall gloomy outlook, Caterpillar continues to return value to shareholders and announced today that it plans to repurchase another $2.5 billion of Caterpillar stock in the third quarter. That repurchase is a part of the $10 billion repurchase previously approved in the first quarter of 2014, but as long as Caterpillar continues to generate cash flow -- consider that 2012 and 2013 were Caterpillar's best two years in history for cash flow generation -- it will be the bright side of holding this stock until mining markets overseas turnaround and inject the company's resource industries with profitability. Also, from the beginning of 2013 through the end of next quarter, Caterpillar will have repurchased $6.2 billion of stock and increased its dividend twice.

Below, you can see how Caterpillar has drastically reduced shares outstanding and increased its dividend over the last 20 years.

CAT Shares Outstanding Chart

CAT Shares Outstanding data by YCharts

Looking ahead
There is some seasonality built into Caterpillar's business and, as such, investors need to keep expectations up to date. In terms of revenue, expect next quarter to check in similar to this year's first quarter; and expect Caterpillar's fourth quarter to check in similar to the second quarter. Also, the company's third quarter is typically its weakest in terms of profitability, and the fourth quarter should be similar results to the first half of 2014. 

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