Were Caterpillar's Earnings Really That Bad?

It wasn't exactly an encouraging earnings report last week for Caterpillar (CAT +0.11%), as the company both missed expectations and cut its full-year 2013 forecast. Caterpillar now expects revenue for the full year to come in between $57 million and $61 million, down from the previous range of $60 billion to $68 billion. Caterpillar also lowered its full-year 2013 earnings per share guidance to $7 from the previous midpoint of $8 per share.

Here are Caterpillar's first quarter results compared with last year's first quarter and analyst expectations for this quarter.

Source: S&P Capital IQ. Analyst estimates from Bloomberg.

Despite the disappointing results, Caterpillar's stock actually ended the day up solidly after its earnings were released. So what gives?

Part of the reason is a lot of bad news was already baked in to Caterpillar's stock price. Investors simply haven't been expecting much from the company lately, with the stock trading for a P/E of around 10 before the earnings release. Caterpillar also resumed its shareholder-friendly stock buyback plan, announcing that it will repurchase $1 billion in common stock from Citi. The company initially started a repurchase plan in 2007 with plans of buying back $7.5 billion in stock, but the plan was put on hold at the end of 2008 after $3.8 billion in repurchases. Caterpillar paused the buybacks to focus on strengthening its balance sheet and improving cash flow.

Inventory reductions
One of the reasons for Caterpillar's disappointing first-quarter results was the continued reduction in both dealer and company inventory. Caterpillar inventory was reduced by $500 million in this year's first quarter versus year-end 2012, an encouraging result especially when compared with a $2 billion increase in inventory in 2012's first quarter.

Similarly, dealer inventory also decreased in the first quarter of 2013. Dealers bought less equipment than they sold to customers, decreasing inventory by about $700 million in 2013's first quarter versus year-end 2012. That compares with an increase of $875 million in dealer inventory in the first quarter of 2012. Net those out, and you're looking at a negative $1.6 billion impact just based on the trimming of dealer inventories quarter-over-quarter.

Mining problems
Going forward, investors need to keep an eye specifically on Caterpillar's most important segment in the long term: resource industries. Mining accounts for about 80% of the resources industries segment's revenue, and it's an area where Caterpillar continues to face some serious headwinds. While CEO Doug Oberhelman recently told CNBC that "we're close to a floor in mining," management also stated on the conference call that the mining backlog declined in the first quarter and that mining is the primary reason for the company's reduced full-year 2013 outlook. Management also said it now expects the march down of dealer inventory in mining to continue at least to some degree throughout much of 2013. Most of Caterpillar's first-quarter sales declines year-over-year from last year was due to the resource industries segment.

30,000-foot view
While resource industries will continue to be the big drag on revenue this year for Caterpillar, this is probably more short-term in nature, and investors should remember that mining is a highly cyclical segment.

There is still a ton of opportunity in mining when looking years and decades out. That's why General Electric (GE 1.81%) launched a new business unit, GE Mining, last September. GE expects the unit will reach $5 billion in sales "within a few years," building on recent acquisitions of Fairchild International and Industrea Limited.

For Caterpillar, its construction and power systems segments will perform better on a sequential basis than its slumping resource industries segment this year, but the company continues to be in a promising position as the world's largest mining equipment maker, which still looks to be its key long-term growth driver.