Despite the several challenges facing Caterpillar Inc. (NYSE:CAT), the stock has shown remarkable resilience in recent months, gaining almost 15% since mid-May. Rival Joy Global Inc.'s (NYSE:JOY) surprise earnings beat last month amid a recovery in prices of commodities such as copper fueled hopes of a turnaround in the mining industry, which is critical to Caterpillar's growth.
However, Joy Global confirmed that the mining industry is still in the doldrums. Meanwhile, oil prices remain volatile, China is sending mixed growth signals, and the Brexit is a big concern. So can Caterpillar stock sustain its rally? The heavy-equipment giant's upcoming second-quarter earnings report on July 26 should give you some answers, provided you don't miss the following three key updates in the report.
The Brexit impact
While it's too early to say how the Brexit will affect the global economy, Caterpillar could be hit on several levels. To begin with, the U.K. is a key manufacturing and export base for Caterpillar, with 20 key facilities. Potential trade restrictions post-Brexit could hurt the movement of goods between the U.K. and Europe and hit Caterpillar's sales. Meanwhile, the strengthening of the dollar in the aftermath of the Brexit vote will mean lower revenues for Caterpillar, thanks to its substantial international exposure.
In fact, I'm expecting a stronger dollar to play a key role in driving Caterpillar's Q2 and full-year revenues lower. I expect Caterpillar's Q2 revenue to fall at least 20% year over year, and I wouldn't be surprised if the company downgrades its full-year guidance again, as it did in Q1.
Investors particularly need to keep an eye on any updates that Caterpillar management might provide on Brexit's impact on the company's growth plans.
Energy and transportation: bad news ahead?
End market conditions for Caterpillar's energy and transportation (E&T) segment, which made up almost 40%of its machinery sales last year, are showing no signs of improvement. Oil and gas and transportation, especially rail and trucking, have been particularly weak. During its last earnings call, competitor General Electric (NYSE:GE) highlightedhow tough transportation markets are, as it saw its orders slump 56% year over year. More importantly, General Electric's locomotive shipments declined 27% year over year. Rail was Caterpillar's weakest transportation market in Q1 and was also largely responsible for the company's guidance downgrade.
Meanwhile, bellwether Alcoa Inc. (NYSE:AA), which recently reported its second-quarter numbers, projects softer transportation markets going forward. Alcoa is particularly bearish about the North American oil and gas and heavy-duty trucking market: It projectsthe latter to decline 26% to 28% this year.
Investors must watch E&T numbers closely in Caterpillar's Q2 earnings report. It's worth remembering that E&T was Caterpillar's worst-performing segment in Q1, reporting 33% lower year-over-year revenue, with 80% of it coming off oil and gas and transportation. With the Brexit pushing oil prices lower, also look for any telltale signs in Caterpillar's earnings call -- such as further restructuring or shutting of plants -- that could indicate longer-term pain for the company.
Will North America surprise or shock?
With construction activity in international markets weakening, especially in Latin America and China, Caterpillar was betting on domestic markets for growth. Unfortunately, North America is also showing signs of stress. Consider this: Caterpillar's construction equipment retail sales from North America declined 11% during the three months through May, compared with only a 3% drop earlier this year for the three months through February.
It goes without saying that a slowdown in construction markets at a time when mining and oil and gas industries are reeling will be a huge blow to Caterpillar. Keeping an eye on Caterpillar's construction industries sales and dealer inventory numbers in its Q2 report might help investors gauge what the future holds for the company. On a positive note, it's worth noting that Alcoa projects North American construction market to grow 4% to 5% this year. So there's still hope for Caterpillar investors.
Most of the headwinds facing Caterpillar could have long-term implications, and that's what investors must focus on in the company's Q2 report.