BLOG: Would Cat be better off at half the size?

By Joe Cahill, Crain News Service

CHICAGO (April 24, 2015) — Caterpillar Inc.'s efforts to slim down in the face of plunging sales don't go nearly far enough, according to one Wall Street analyst.

In a wide-ranging critique, Andy Kaplowitz of Barclays Capital writes that the heavy-equipment manufacturer's $1 billion cost-cutting campaign is only “scratching the surface” of its excess production capacity.

“We think Cat has significant opportunity to take additional costs out of the business,” Mr. Kaplowitz says in his March 24 report. He doesn't say how much more expense the company should shed, but argues that a combination of deeper cost cuts and share buybacks could boost earnings per share by 10 percent. His analysis rests on a conclusion that Cat has twice as much capacity as it needs.

“It seems Cat has physical capacity to support at least $70 billion and potentially as much as $100 billion in sales” at a time when it expects annual revenue of about $50 billion in 2015. Cat's sales have dropped 24 percent since 2012, to $55.18 billion last year, largely because of plummeting demand for mining equipment,” according to the report. “Things are likely to get worse before they get better, as falling oil prices dampen demand for drilling equipment and construction markets sputter.”

Mr. Kaplowitz's report signals that Cat's goodwill on Wall Street is running low. Its share price has declined 26 percent over the past three years as hopes for a quick turnaround faded. During the same period, the Standard & Poor's 500 index gained 45 percent and S&P's index of industrial stocks climbed 46 percent.

Nevertheless, Caterpillar CEO Doug Oberhelman has escaped pressure from the activist investors who have forced other lagging companies to slash costs and plow cash into share buybacks. At this point, there's no indication an activist has taken a position in Cat. But that can change quickly. “If Cat doesn't think like an activist, we think others could,” Mr. Kaplowitz warns.

Thinking like an activist would mean plant shutdowns and job cuts that go far beyond those currently on the table. Cat's total headcount of 114,233 is down about 11,000 over the past two years, according to company filings. The Peoria-based manufacturer also has shut seven plants in its resource industries unit, which makes large trucks and other equipment for mining companies. Layoffs have claimed hundreds of jobs at mining equipment plants in Decatur and Peoria.

Yet Mr. Kaplowitz expresses surprise that Cat's expense reduction plans for 2015 include no “large-scale plant closure.” He writes: “Our simple question is why not?”

Cat declines to discuss Mr. Kaplowitz's report, but other analysts say executives may be focused on maintaining market share in a cyclical industry. If Cat cuts capacity so dramatically that it can't meet demand when markets recover, competitors could gain ground. “They're trying to play the long game,” says analyst Mircea Dobre of Robert W. Baird. “This might be the wrong time to shutter capacity.”

Few doubt mining markets will come back at some point. The question is when and how much. Mr. Kaplowitz, for one, doubts Cat will see “sustained, multiple-year end market growth” anytime soon.

Investors might be more willing to trust Cat's crystal ball if Mr. Oberhelman had shown better timing in the past. He dramatically increased Cat's exposure to mining just before the crash, paying a 32 percent premium for South Milwaukee-based Bucyrus International in a $7.6 billion deal four years ago as commodity prices peaked. He got more egg on his face when it turned out a company he bought in China had been cooking the books.

So it's not surprising some are starting to question his ability to forecast the timing and extent of an eventual recovery in mining markets. The longer it takes, the more pressure he'll face to cut deeper.

Columnist Joe Cahill wrote this blog for Crain's Chicago Business magazine, a sister publication of Tire Business.