What Caterpillar's Slump Says About Its Future

For the fourth quarter in a row, Caterpillar (CAT 1.29%) fell short of analyst's earnings expectations. While the market shrugged off modest reports from industrial peers Honeywell (HON 0.98%) and GE (GE 1.47%), it's unlikely to do the same for the heavy equipment manufacturer. By mid-morning, Caterpillar's stock tumbled 5%, whereas Boeing (BA 0.96%) bounced 5% higher on a strong earnings report. Can Caterpillar dig itself out of a hole, or are there better buys in this industrial sector? Let's take a closer look.

A roller coaster ride for investors
Caterpillar's recovery after the market meltdown in 2008 was nothing short of spectacular. From the depths of the recession through early 2011, Caterpillar gained over 350%. Since then, however, Caterpillar's been on a roller-coaster ride, and peers Boeing and Honeywell have raced ahead in returns over the past five years.

CAT data by YCharts

While each of these companies operates in unrelated product markets, it's nonetheless interesting to compare their fates. All three companies have made significant investments around the world, with a particular emphasis on fast-growing markets in Asia. At the same time, leaders at each have expressed ambitions of detaching their performance from the boom-and-bust cycles increasingly common in the global economy. For Caterpillar, the company has placed a heavy emphasis on two areas in particular: mining equipment and China. These bets might seal the company's fate in the near-term, but whether investors should be concerned over the long haul is a different question.

Shaking out Caterpillar's quarter
From mining to construction, there wasn't a whole lot of positive news that emerged from the Caterpillar camp during today's earnings call. As shown below, revenue fell 18% and earnings dove 43% when compared to the same period last year.

Source: Caterpillar 10-Q

CEO Doug Olberhelman, a typically straight-shooting executive, admitted the company faced a difficult year, and commented on expectations -- both revenue and net income estimates were lowered -- for the rest of 2013:

This year has proven to be difficult, with expected sales and revenues nearly $11 billion lower than last year. That is a 17 percent decline from 2012, with about 75 percent of the drop from Resource Industries, which is principally mining. We expect Resource Industries to be down close to 40 percent for the full year and Power Systems' and Construction Industries' sales to each be down about 5 percent.

Beyond lowering 2013 estimates for revenues to $55 billion from a range of $56 billion-$58 billion, the management team expressed concerns looking ahead to 2014. While it was noted in the release that "the company expects better world growth in 2014," Caterpillar predicts revenues will remain flat compared with the current year.

Such a tepid outlook is what will concern many investors about the stock at this point, but it's not an open-and-shut case by any means.

What lies ahead for investors 
Long-term shareholders in Caterpillar have seen this story unfold before. As one of the leading indicators of economic growth, Caterpillar's orders can be highly volatile depending on the economic environment. But CEO Olberhelman cut his teeth dealing with steep downturns and recognizes that the company must operate as lean as possible.

Buying into Caterpillar at this point likely depends on your time horizon. The company has made massive investments in its China operations and noted in its release that sales in this area grew over 30% -- a bright spot in an otherwise dismal quarter. Further, the company maintains a strong balance sheet and has diversified its revenue base over the years through investments in mining. While the mining sector stands on shaky ground today, it's unlikely that global demand will taper as resources grow increasingly scarce over the next few decades.

After a spat of industrial earnings, Caterpillar's near-term outlook lags GE's and Honeywell's and trails behind aerospace giant Boeing by a long shot. Yet GE, Honeywell, and Boeing trade at 9.4, 17.1 and 9.6 times cash flow, respectively, compared to Caterpillar's 7.6. Those investing for the ultra-long haul could find Caterpillar attractive, but be prepared for choppy waters over the next few quarters.

Editor's note: A previous version of this article misstated revenue and earnings variance. The Motley Fool regrets the error.