Caterpillar’s stock has had a frustrating year. Year-to-date, its price has fallen more than 26 percent. On Thursday, Caterpillar closed at $115.63, well below its 2018 high of $170.89 set on Jan. 22.
The fundamental driver of a company’s stock price is the ability to generate revenues and profits from the sale of its goods and services. Yet, contrary to its declining stock price, Caterpillar’s revenues and profits this year have been exceptional.
In April, Caterpillar reported its highest first quarter profit per share in its 93-year history. Its revenues and profits increased by 31 percent and 454 percent, respectively, from the prior year. In July, Caterpillar reported its highest second quarter profit per share in history, growing its revenues and profits by 24 percent and 83 percent, respectively. Finally, this past Tuesday, Caterpillar reported its highest third quarter profit per share in history. Its $13.5 billion in revenues and $2.14 billion in profits increased by 18 percent and 41 percent, respectively.
In total, that’s three consecutive quarters of record profitability and stellar revenues, all which exceeded market expectations. Moreover, Caterpillar cited a growing global and domestic demand for its goods and services as the key factor for this success. So, why then, despite these impressive quarterly earnings reports, does Caterpillar’s stock continue to struggle?
Equally important to a company’s actual quarterly results is its forward guidance, or its outlook, on future revenues and profits. Yes, in its last three quarterly reports, Caterpillar projected a growing consumer demand for its products. However, it also acknowledged it would be facing increasingly higher operating and manufacturing costs caused by rising inflation, interest rate hikes and U.S. tariffs on imported steel and aluminum. For the full year 2018, Caterpillar expects an added $100-$200 million of tariff-related costs. To offset these costs, Caterpillar started to raise consumer prices at the end of the second quarter, which it confirmed will continue into 2019.
There’s also growing uncertainty on the health of the global economy. Global stock markets were sent reeling last week amid renewed anxieties over China’s economy. China has the world’s second largest economy and its economic growth rate this year is now projected to reach a 28-year low. A weakening Chinese economy could spread like a contagion to other global markets, including the U.S. – China’s largest trading partner. From Monday to Wednesday, the Dow Jones Industrial Average fell 860 points, or 3.4 percent.
China accounts for, on average, 5-10 percent of Caterpillar’s total sales and revenues. In its investor conference call on Tuesday, Caterpillar CEO James Umpleby stated, “Based on everything we see, we believe that the China market will continue to be healthy.”
Caterpillar’s actual financial numbers continue to impress. However, like many other U.S. manufacturers, it is unable to shake the growing concerns that rising costs and global trade disputes will, at some point, start to materially disrupt future revenues and profits. Unfortunately, for Caterpillar, uncertainty is driving its stock price.
Despite some notable setbacks, so far, the third quarter corporate earnings season has been solid. Of the 198 (39.6 percent) S&P 500 companies that have reported so far, third quarter earnings have increased by 23.6 percent over the past year, above the pre-season estimate of 19.3 percent. Also, third quarter revenues have increased by 7.6 percent, above the initial 7.3 percent estimate.
Of the 11 sectors that make up the U.S. economy, the energy sector has reported the highest earnings growth rate. To date, third quarter revenues for energy companies have grown by an astounding 100.9 percent. Rounding out the Top 3 are the financial sector (44.2 percent growth rate) and the materials sector (27.2 percent growth rate). The materials sector consists of companies involved in the discovery, development and processing of raw materials such as metals, chemicals and forestry products.
The industrial sector, which includes manufacturing and construction companies, currently ranks fifth, with earnings growth of 19.8 percent. 41 of the 71 industrial companies in the S&P 500 have so far reported, with local companies Arconic (Oct. 30) and John Deere (Nov. 16) due in the upcoming weeks. The bottom three sectors for earnings growth are consumer staples (9 percent) – companies that produce food, beverage and household goods – utilities (6.2 percent) and real estate (4.7 percent).
Finally, of the 140 companies that have reported, 82 percent have reported earnings better than initial market expectations. For the industrials sector, this rate is an impressive 80 percent.