Caterpillar Inc.'s Worst Segment in 2015

Image source: Caterpillar.

Investors in Caterpillar know all too well just how tough the heavy-equipment maker has had it lately. With the global economy having been in the doldrums for years, sales of construction equipment for commercial building and infrastructure development have fallen steadily for years. The decline in the prices of precious and base metals threw the mining segment into disarray, being particularly ill-timed after Caterpillar's purchase of Bucyrus. Yet Caterpillar's worst segment in 2015 was also the last domino to fall, as the plunge in oil prices sent the company's energy business plummeting along with it.

Let's look more closely at Caterpillar's energy segment to see how it reacted to tough times.

How Caterpillar got energeticCaterpillar's energy and transportation segment has become much more important since the energy boom of the 2000s. Until recently, the segment was called Power Systems, referring to the equipment that helped oil and gas exploration and production companies produce power in remote drilling locations. As a leading provider of reciprocating engines and gas turbines, Caterpillar equipment helped produce both primary and backup power as well as heat and other applications.

Yet Caterpillar has expanded in the direction of energy in recent years. A joint venture with Ariel allowed the company to provide products to help well drillers meet their pressure-pumping needs, and Caterpillar also makes centrifugal natural gas compressors for the energy industry.

In doing so, Caterpillar ran headlong into General Electric and its own emphasis on servicing the energy segment. For its part, General Electric looked at oil and gas services as an important driver of long-term growth, complementing its renewable-energy business well and allowing General Electric to tap into the strong trends that the oil and natural gas industry experienced throughout much of the past decade.

At the same time, Caterpillar's commitment to the transportation industry has also remained important. In the railroad area, the company offers locomotives as well as signal and track services. In the marine area, Caterpillar makes propulsion and control systems as well as marine engines and auxiliary power products.

Despite the broader focus of the segment, energy has been the key to its success. During better times, the segment grew its revenue by half just from 2009 to 2011, and continued to grow through 2012, until natural gas prices fell to highly depressed levels. Profit growth continued, however, and reached its best level in 2014, with the segment earning more than $4 billion in pre-tax earnings for Caterpillar.

How Caterpillar's energy business did in 2015Caterpillar's sales have fallen sharply throughout its business, and the energy segment doesn't stand out all that much in that respect. Through the first three quarters of the year, revenue from the energy and transportation business fell 13.4% to $14.9 billion. That was actually a slightly less dramatic drop than the 13.8% decline in the construction segment, but the energy area's larger size made the percentage drop equate to an outright $2.3 billion loss of revenue.

Where Caterpillar's energy business really hurt was on the bottom line. Pre-tax operating profits year to date were down 16% to $2.53 billion, and the nearly half-billion dollar decline from year-ago levels was worse than the drop in profits for the construction and resources divisions combined.

CEO Doug Oberhelman has consistently taken a long-term view of the prospects for the energy business. "Long term," the CEO said, "I think all of you are aware of the population growth in the planet [and] the demand for electricity. ... We expect over time this industry to come back." In particular, Oberhelman pointed to forecasts from the Energy Department for healthy growth in demand over the next 20 to 30 years, including nearly every aspect of energy production.

What's next for Caterpillar's energy business?Despite the long-term optimism, Caterpillar doesn't have high hopes for the energy segment in the near future. Back in October, the company said it expects the Energy and Transportation segment to suffer a 5% to 10% drop in revenue in 2016 compared to year-end 2015 levels. Caterpillar made a point of emphasizing that nearly all of that decline will come from oil and gas applications, noting the difficulty the industry faces in trying to bounce back with energy prices at current levels.

Even with the challenges, Caterpillar investors need to understand that the energy business will keep playing an important role in the heavy-equipment maker's overall success. Once energy prices show signs of stabilizing, meeting pent-up demand for new equipment could help drive the next recovery for Caterpillar in the future.

The article Caterpillar Inc.'s Worst Segment in 2015 originally appeared on Fool.com.

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