5 Things Caterpillar Inc. Management Wants You to Know

Choppy road ahead

Caterpillar's VP of strategic services, Mike DeWalt, shared his broader outlook during the earnings call: "Despite cautious optimism for improved global economic growth, significant risks and uncertainties remain and that could temper growth in 2015."

Remember, this was before oil prices plunged.

DeWalt was primarily talking about market-specific risks, such as "political conflicts and social unrest" in regions like the Middle East, Africa, and Commonwealth of Independent States (read: Russia). DeWalt also expressed concern about China, elaborating how the "Chinese government's push for structural reform has slowed growth."

So why are these markets so important for Caterpillar? Europe, the Middle East, and Africa made up nearly a quarter of the company's total revenue last year. And while China isn't a big a market yet, it's Caterpillar's key target for growth. Unfortunately, slowdown in China was primarily why Caterpillar's sales from the Asia-Pacific region crashed 27% in 2013. Overall, the region contributed roughly 22% to total sales.

Not surprisingly, management is cautious: It predicts Caterpillar's 2015 revenue will be "flat to slightly up" at best, thanks to global uncertainty.

But again, that was before oil prices plunged.

Oil price: A huge challenge

Caterpillar CEO Doug Oberhelman doesn't mince words. During a recent discussion about oil prices on CNBC, he shot straight when he said that "there is no question now there is going to be an impact" of lower oil prices on the company. But what Oberhelman said during the company's last earnings conference call should give you a better idea of how big the blow could be: "I think if you see low $70s on a sustained basis, there would be a chill across the market and I'd say gas coming down below $3 substantially on a sustained basis may do that as well."

With oil crashing below $50 a barrel, investors can gauge how cold it must be getting for Caterpillar out there. Expect Caterpillar's largest and most profitable business segment, energy and transportation, to take the biggest hit, since oil and gas is a primary end market. Remember, the company is already expecting softness in its locomotives business -- again, a key end market for the E&T division.

Will Caterpillar lose this game?

DeWalt made it clear during the earnings call that Caterpillar's locomotive sales will remain soft in 2015. "If we take locomotive specifically, no doubt next year is going to be lower," he said. While DeWalt pegged the potential impact to be "less than 2%" on the E&T division, there's a lot more to the story.

General Electric Tier 4 locomotive. Source: General Electric.

Caterpillar is already losing to General Electric in the locomotives race. While Caterpillar's EPA Tier-4-compliant freight locomotives may not be ready until 2017, General Electric is ready to roll out its Tier-4 offerings this year. Unlike Caterpillar's forecast, railroads have shown high interest in transitioning to new emission standards. GE is bound to grab the early-mover advantage -- and all this could weigh heavily on Caterpillar's E&T business.

Meanwhile, Caterpillar continues to struggle with the prolonged mining slowdown. But there's a silver lining.

Worst over for mining?

During the conference call, while DeWalt mentioned that purchases of new mining equipment are still at "low levels," he also pointed out that sales and profits are stabilizing. Referring to Caterpillar's Resource Industries (primarily mining) division, DeWalt explained: "While sales this year are below last year, the 2014 quarterly sales trend has been pretty stable with $2.1 billion in the first quarter, $2.2 billion in the second quarter and $2.2 billion in the third quarter."

DeWalt presented a similar picture on the profit side: "While profit in Resource Industries is down from a year ago, much like the sales, it's been in a fairly tight band throughout 2014. In the first quarter, profit was $149 million, second quarter was $133 million and the third quarter was $147 million."

Those numbers may not present a rosy picture, but the quarter-to-quarter trend suggests bottoming, which is exactly what the market is waiting for. Of course, Caterpillar's mining sales and profits are at very low levels, but even a slight improvement from here could buoy investors' optimism. 2015 could just be the beginning.

Meanwhile, Caterpillar is working hard to turn challenging times into an opportunity to improve.

One area you need to watch for

Caterpillar has initiated aggressive cost-cutting in recent quarters. Oberhelman explained it in an interesting way during the earnings call: "In a way, flat production really gives us time, flat production output gives us time to get to work on this. When things are booming, it's hard to work on efficiency because we're trying to satisfy the market."

In other words, Caterpillar can focus better on improving efficiency and margins in downtimes when it doesn't have to worry about production and demand. Over the nine months ended September last year, Caterpillar reduced its manufacturing costs by 3%, helping it boost its operating profit by 2% despite as much of a drop in sales.

On an encouraging note, Oberhelman believes "there's a lot more work to do" and expects "big chunks" of it to come through in 2015. With business conditions remaining tough, any effort to boost margins could go a long way in securing a strong future for Caterpillar.