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Caterpillar, Inc.'s First-Quarter in One Word: Ouch.

By Daniel Miller - Apr 26, 2016 at 3:45PM

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Here's a look at Caterpillar's rough first-quarter, and why it wasn't even as good as it appears.

Another quarter and another brutal financial result for Caterpillar, (CAT 3.20%) investors. Even management has essentially given up on trying to spin things in a positive light, because it just isn't possible.

"While first-quarter results were about as we expected, sales and profit were well below the first quarter of 2015. Sales declined across the company with substantial reductions in construction, oil and gas, mining and rail. While many of the industries we serve are challenged, we remain focused on what we can control: the quality of our products, our market position, safety in our facilities and continued restructuring and cost reduction." said Caterpillar Chairman and Chief Executive Officer Doug Oberhelman, in a press release.

Let's take a quick look at the sales and operating profit results, how safe the dividend is, and why its results aren't even as great as they appear.

Sales and revenues
Declining sales volume, price realization, and currency woes all combined to send Caterpillar's total sales and revenues down to $9.46 billion during the first-quarter of 2016, which compares poorly to last year's $12.7 billion. Sales declined in all regions, and sales declined in all segments.

Chart by author. Information source: Caterpillar quarterly filings.

More specifically, Asia/Pacific sales declined 23% thanks to declining demand for Energy & Transportation applications and products used in mining. Meanwhile, sales plunged even worse in Latin America where Caterpillar posted a 43% decline during the first-quarter, mostly due to economic weakness in Brazil and Mexico.

When it rains it pours, and with such a substantial decline in sales Caterpillar's operating profit followed. The company's operating profit declined from $1.7 billion during the first-quarter of 2015 down to $494 million in the first-quarter of 2016. Caterpillar's profit per share declined to $0.46 during the first-quarter, down from $2.03 per share during the same period last year. Excluding restructuring costs Caterpillar's first-quarter profit per share reached $0.67, still a far cry from last year's $2.07 per share.

Chart by author. Information source: Caterpillar quarterly filings.

With a brutal first-quarter out of the way, management reduced the top end of its full-year guidance. Caterpillar now expects sales and revenue to check in between $40 and $42 billion for 2016, down from the prior range of between $40 billion and $44 billion. It also expects profit per share to be between $3.00 per share and $3.70 per share, excluding restructuring costs.

On the bright side...
One thing investors continue to ask themselves is whether Caterpillar's dividend is safe. So far, management hasn't wavered on the importance of its dividend.

"We can fulfill all the priorities we have," Chief Financial Officer Brad Halverson said in an interview with Bloomberg. "The dividend is very safe in my view in terms of the cash flow that we're generating, and the pension is very well funded. We use excess cash to buy back stock so it's the last priority in terms of the equation." 

It's true, Caterpillar's cash flow has remained resilient over the past few years, despite challenging environments.

Chart by author. Information source: Caterpillar quarterly filings.

However, Caterpillar's cash flow is expected to drop roughly 32% to $2.3 billion this year, according to analysts' estimates, which could end up as the weakest full-year result since the past recession. While all of the information thus far has been rough enough for investors, the truth is that the first-quarter results aren't even as good as they appear.

Pension changes
At the end of 2015 Caterpillar mentioned it would be implementing a change in accounting principles for pension and OPEB costs. Because of that change to 2016 financial information, Caterpillar has adjusted its 2015 results to compare fairly with this year's results. That accounting change added $0.68 profit per share to 2015's results, moving it from $3.50 per share to $4.18 per share.

According to research firm CFRA, it estimates the change will inflate 2016's profits as well.

"We estimate that the benefit from these changes will account for approximately 21.5% of CAT's earnings in 2016. It is important to understand that these changes are non-cash in nature and any earnings growth from the changes will not be sustainable. Further, these changes could be a drag on earnings growth in future years depending on interest rate movements."

At this point most investors realize things aren't going to get better rapidly, and it's not far off to think things could get worse globally before they get better, in terms of Caterpillar's business. The silver lining is that the company continues to cut costs efficiently, its cash flow has thus far remained resilient, and maintaining the dividend remains a high priority. While buying beat down companies at or near the bottom of a business cycle can pay off, investors attempting that strategy with Caterpillar will need years of patience. 

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