Shares of Caterpillar (NYSE: CAT) have tumbled down in recent weeks by more than 15%. The recent downgrade of the company by Goldman Sachs isn’t likely to pull up Caterpillar’s stock. Does this mean Caterpillar is facing dire times ahead? Is it time to reevaluate this company? Let’s have a close look at this company, and evaluate its performance compared to related companies and the heavy machinery industry.
Caterpillar’s revenues grew by nearly 9.5% during 2012 compared to 2011. Moreover, the company’s operating profit expanded by almost 20%. Therefore, the company’s profitability grew from 8.2% in 2011 to 8.6% in 2012. So the company grew in 2012 despite the slowdown in China’s growth and the ongoing debt crisis in Europe. But if the company did so well, why Caterpillar’s stock isn’t pulling up?
Looking back to 2011, the company’s growth was much more impressive as its revenues grew by more than 40% and its operating income increased by 80%. This puts the company’s growth in 2012 in a different perspective. Moreover, looking into 2013, the company’s outlook (page 2 of its fourth quarter financial reports) isn’t optimistic: Its revenues are expected to range between $60 and $68 billion. The company’s revenues reached $65.8 billion in 2012. In other words, the company doesn’t expect its revenues to grow much (if at all) during 2013. This wide range is due to the company’s uncertainty around its future growth in leading economies including U.S, Europe and China.
Compare to some other heavy machinery companies such as Joy Global (NYSE: JOY), Deere (NYSE: DE) Caterpillar’s growth in revenues was less impressive: Joy Global’s revenues grew by more than 28% during 2012; the net sales of Deere increased by 13%. But not all heavily machinery companies did well in 2012: revenues of Cummins (NYSE: CMI) declined during 2012 by 4%.
In terms of operating profitability, Caterpillar is in the middle of the pace with a profit margin of 13% during 2012. Its profit margin grew in recent years, but didn’t pass the profit margin of other heavy machinery companies. As presented in the chart below, Joy Global is leading the way with over 20% profit margin. Deere and Cummins, each have a profit margin of nearly 13%.
At least in terms of dividend yield, Caterpillar is leading the way with an annual yield of 2.45%. In comparison, Joy Global pays an annual dividend of $0.70 per share per year, which comes to an annual yield of 1.25%; Deere offers an annual yield of 2.4%; Cummins pays a yearly yield of 1.8%.
Caterpillar’s payout ratio isn’t high and reached 24% in 2012. But compared to other companies in its industry, Caterpillar’s payout isn’t low. The table below shows that Joy Global has the lowest payout ratio while Deere and Cummins have similar payout ratios to Caterpillar’s.
One of the reasons these companies don’t offer a high payout ratio is due to their high spending of investing activities that leave these companies free cash flow very low or even negative: Caterpillar’s free cash flow in 2012 was ($949) million; Deere also had a negative FCF of over $2.8 billion; Cummins and Joy Global had a positive FCF of $340 million and $74 million. For Joy Global, however, this wasn’t enough to pay its dividend for 2012. If these companies’ operating cash flow will continue to dwindle in 2013, as it did in 2012, this could mean these companies might lower their payout ratio or cut on investment expenses. Either way this scenario will make these companies stocks less attractive.
So Caterpillar offers a low payout but a reasonable dividend yield. These figures are sensible compared to other companies in the heavy machinery industry but unimpressive compared to other industries. Therefore, I doubt these figures will be enough to attract investors to Caterpillar’s stock. I think that investors will keep looking on the company’s growth as one of the leading factors that could impede the company’s stock from rising. So will Caterpillar be able to grow in 2013?
I will divide the issue of growth into three main economies: U.S, Europe and China.
The latest debacle that Caterpillar had with the Siwei purchase in China, in which an accounting misconduct led Caterpillar to add a $580 million provision for goodwill impairment in the fourth quarter 2012 reports, may eventfully lead the company to reconsider any future acquisitions in China. In such a case, this could pull down the company’s growth in China. Moreover, China’s economy didn’t grow in 2012 at a high rate as it did in previous years. China’s GDP growth rate ranged between 7.4% and 8.1% (annual rate; per quarter) during 2012. In 2011, the growth rate ranged between 9.7% and 8.9%. If China’s economic growth will decline again in 2013, this could suggest that Caterpillar’s growth will also suffer.
The U.S economy is showing some signs of recovery. But the recent decision to implement the government spending cuts of $85 billion during 2013 might curb the growth of the U.S economy and perhaps even the government spending in infrastructure – one of Caterpillar’s business segments. The net revenues of Caterpillar in North America fell by 13% in the fourth quarter of 2012 (compared to Q4 2011) – the sharpest drop in revenues for a geographical region. This is the largest region in terms of revenues and represents 33% of the company’s total revenues. If sales in this region will also fall, this could be a big hit for the company’s revenues.
The situation in the Euro zone hasn’t improved in recent years and based on the current projections isn’t likely to ameliorate in 2013. The EAME region revenues fell during the last quarter of 2012 by 5% – the second sharpest drop in revenues of all regions. This could also lead to a slowdown in housing and infrastructure developments that will cut Caterpillar’s revenues in this region.
Caterpillar isn’t sure it will be able to produce growth in 2013. Based on the above, I think the company’s revenues might even decline during the year. In such a case, shares of the company might continue to dwindle.
For further Reading see: Why Caterpillar isn’t Rising? Just blame Oil
Disclaimer: The author holds no positions in stocks mentioned and does not plan to initiate positions within 120 hours of the posting of this article. This article is to be used for educational, research and informational purposes only and does not constitute investment advice. There are no guarantees, expressed or implied, of future positive returns in regards to the subject matter contained herein. Understand the risks inherent in investing before making the decision to invest or consult an investment professional for more information. Reasonable due diligence has been performed in regards to the information in this article. However, the author expressly disclaims any liability for accidental omissions of information or errors in fact.