It's a crucial week ahead for Caterpillar Inc. (CAT +0.44%) investors. Shares of the industrial heavyweight have been quite choppy lately amid rising concerns about whether the company can grow its sales and profits to justify the stock's run amid the volatility in metal, coal, and oil prices. An IRS probe for possible tax fraud has only strengthened the case for Caterpillar bears.
Caterpillar bulls, on the other hand, continue to pin hopes on a potential $1 trillion infrastructure stimulus package that could mean big business for the world's largest construction equipment manufacturer. It's a different matter that there's no sign of such a package yet, and how things will pan out is anyone's guess.
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This divided stand is why Caterpillar's upcoming first-quarter earnings report, scheduled for release on April 25, is so critical for investors. As the numbers Caterpillar reports will also set the pace for the full year, investors just can't miss the following three updates in its report.
Caterpillar could beat estimates, but backlog holds the key
Caterpillar investors may remember that the company downgraded its full-year outlook during its last earnings release, but what they might not know is why management did so.
Caterpillar cited "strengthening of the U.S. dollar" as the primary reason that it lowered its fiscal year 2017 revenue guidance by about $500 million to $37.5 billion. The dollar has, however, weakened considerably in the past couple of months, which should lift Caterpillar's overseas revenues.
So there's a chance Caterpillar could beat consensus revenue estimates, though I would expect it to remain cautious and not upgrade its full-year outlook unless its order rates were encouraging, too. Keep an eye on Caterpillar's backlog, as I believe it is the most important leading indicator of what lies ahead for the company. Caterpillar's backlog improved $500 million sequentially last quarter, so another couple of strong quarters could confirm a turnaround.
Higher restructuring costs could dent profits
Caterpillar has aggressively overhauled its business in the past couple of years, laying off 10% of its workforce just last year. While Caterpillar has cut operating costs considerably, it has also had to bear substantial restructuring costs. Consider Caterpillar's last provided FY 2017 outlook: It projected earnings to come in as low as $2.30 per share at the midpoint thanks to an impact of nearly $0.6 from restructuring costs.
My concern is that Caterpillar isn't done yet. Just weeks ago, it announced plans to shut down its plant in Aurora, Illinois. Management didn't account for any potential restructuring costs from this move in its outlook.
So there are two things to watch out for: Higher restructuring costs could mean another guidance downgrade, and any further cost-reduction announcements could mean that the worst might not be over for Caterpillar yet. Both are valid concerns that could pressure the stock going forward.
Is demand from construction markets bottoming?
One indicator of Caterpillar's improving prospects could be its construction industries segment sales. With spending in the mining and oil and gas industries still low, there's little to expect from Caterpillar's resource industries and energy and transportation segments. In such a scenario, strength in its construction equipment business, especially in North America, is essential for growth.
Last quarter, Caterpillar pointed out that North America remains one of the "most concerning regions," and soon followed it up by reporting a 9% drop in its North American retail construction machine statistics for the three months ended February. There's also strong evidence that end users are still wary of buying fresh equipment: Ritchie Bros. Auctioneers (RBA +3.41%), the world's largest industrial auctioneer, reported a record quarterly revenue rate (revenue divided by gross auction proceeds) of 14.1% in Q4. Moreover, Ritchie Bros. pulled off a record auction in Texas last month, indicating that end users are spending more, but on used equipment and rentals.
The point is that if Caterpillar sounds another warning bell for the North American construction markets and remains cautious about other markets, investors may have to wait longer to see its declining profits reverse gear.
Foolish takeaway
No matter what the bulls say, CEO Jim Umpleby, who took the reins this past January, has an uphill climb to turn Caterpillar's fortunes around. If the IRS investigation gets murky, it could deal a huge blow to the company. Meanwhile, management needs to convince investors there's more to the rise in Caterpillar's stock price than just speculation. Let's see if it can do it this week.
