5 Crucial Things Caterpillar Inc. Management Wants You to Know

By Markets Fool.com

It's been a terrible start to the year for Caterpillar investors, with the stock shedding nearly 11% so far in 2015. While investors might consider it a buying opportunity, the heavy-equipment manufacturer is battling fierce headwinds.

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In fact, in its last conference call, management gave crucial insight into why 2015, especially the latter half, could be very painful for the company. At the same time, it also sprung a surprise when it revealed the company's spending plans. Here are five thingsmanagement said on that earnings call that you need to know.

1: When will the big acquisitions pay off?
China might not be Caterpillar's top revenue-generating market, but the company has much at stake in the nation. Investors might recall how the booming Chinese mining industry lured Caterpillar into paying a hefty $8.8 billion for equipment manufacturer Bucyrus International in 2011. Months later, Caterpillar acquired Chinese mining-equipment maker ERA Mining Machinery for $667 million.

Unfortunately, the globalcommodities boom ended soon after, raising questions about the timing of Caterpillar's big-ticket purchase. Worse yet, the company had to take half-a-billion dollarsworth of writedowns in 2012 after it dug up "accounting misconduct" at ERA.


How will Caterpillar dig itself out of the mining mess? Image source: Cat website.

Given the backdrop, a recovery in China is critical for Caterpillar to unlock value from its acquisitions. But going by management's words, investors might have to wait at least another year.Mike DeWalt, Caterpillar vice president for strategic services had this to say on the last earnings call:

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Our sales over the past year have held up better in China than the industry overall, but with lower expectations for China construction, we think our 2015 sales in China will be down.

Until China recovers, Caterpillar can neither capitalize on its largest-ever acquisition nor grow to its full potential.

2: Oil prices will hurt more as the year progresses
Growth in Caterpillar's Resource Industries division wascrippled after mining hit a roadblock couple of years ago. But even as investors wait for mining to recover, the company has another major headwind: lower oil prices.

Nearly one-third of Caterpillar's energy and transportation division sales were to the oil and gas sector in 2014. The damage this is doing to the company is already evident: Caterpillar projects its 2015 revenue to be nearly 10% lower over last yearthanks to lower oil prices. DeWalt further elaborated:

I think if oil prices and gas prices don't go up -- and we're not forecasting them to -- we would have much more of a falloff of the oil and gas sales in the back half of the year, which would imply more of a negative in the back half.

The last bit is interesting, because the impact of lower oil prices won't really show up in Caterpillar's numbers until the third and fourth quarters. That's because the company is selling out of its backlog -- simply, fulfilling orders received earlier when end markets were much stronger -- which is why it reported 18% higher year-over-year retail sales for oil and gas for the three months ended February. But as the backlog depletes and fresh orders dry up, Caterpillar's energy and transportation division sales figures will worsen. Investors should brace themselvesin the second half.

3 & 4: Currency and commodities are major headwinds
While oil prices have put Caterpillar in a difficult situation on top of the existing weakness in mining, it isn't the only headwind. DeWalt again, from the earnings call:

Year over year, we expect a stronger dollar to be a sales headwind.

The continued decline in commodity prices and continued efficiency improvements by our mining customers have caused us to lower our sales estimate for Resource Industries in 2015. With weakness in agriculture, we're also expecting lower sales of industrial engines. And we expect our rail business to be down in 2015 after a great year in 2014.

Each of these factors has contributed to Caterpillar's muted outlook for 2015. Falling prices of key commodities including copper and iron ore could trigger another round of spending cuts by mining companies. If that's bad news for Caterpillar's Resource Industries division, low crop prices could hurt demand for engines that are part of the E&T product portfolio. Overall, a stronger dollar means lower total revenue and profits since the company has substantial operations outside the U.S.

Unfortunately, Caterpillar can't do much about these uncontrollable factors; but that isn't stopping the company from exploring growth options, either.

5: Investing in the future
After aggressive restructuring in 2014, Caterpillar will continue to reduce costs this year, albeit on a smaller scale. It expects restructuring costs to come down from $441 million in 2014,to $150 million this year.

Caterpillar's newly opened first Data Innovation Lab. Source: Company website

The company plans to spend more on research and development this year even as it reduces operating expenses. As DeWalt explained during the call:

We are in a very competitive and changing world, and products and services do matter. We understand the need for profit in the short term, but we also need to invest in the future. That's the main reason R&D is increasing.

DeWalt expects higher R&D to go into "new and updated products and more work on new technologies." While he didn't give out a specific number for the year, DeWalt hinted that R&D will probably not reach 2012 levels yet, when the company spent $2.5 billion.For comparison, it spent $2.1 billion in 2014.

Caterpillar is also looking at "growth opportunities" in 2015, pegging its capital expenditures at about $1.6 billion, roughly 7% higher than last year. Is the company eyeing an acquisition? This seems likely, particularly as management said it is studying the drop in "energy valuation."

While it's too early to saywhether management will be able to convert challenges into opportunities, any step to curtail costs should position the company better for the next growth cycle.

The article 5 Crucial Things Caterpillar Inc. Management Wants You to Know originally appeared on Fool.com.

Neha Chamaria has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.