Company Trend Analysis - Caterpillar: Recovery To Continue At A Slower Pace - SEPT 2017
BMI View: 2017 will mark a turning point for Caterpillar, as the company looks on track to post its first revenue growth since 2012. Construction will remain a driving force behind the company ' s growth over the coming 18 months, whilst both the mining and energy industries will see a mixed performance over the same period as commodity prices remain volatile and companies hold off from expanding investment . Over the multi-year horizon, Caterpillar ' s ability to progress on its technological innovation projects will be crucial to its competitiveness.
Our view that Caterpillar would begin its recovery in 2017 is playing out, with the company on track to see its first full year of revenue growth since 2012. The company reported a 6.8% y-o-y increase in sales and revenues for the first half of 2017 and upgraded its full year guidance for a second time, and is now targeting USD42-44bn in sales and revenues for the year as a whole, which at a mid-way point would indicate an 11.6% increase in revenues y-o-y.
This pace of growth is unlikely to be sustained at current double digit levels over the second half of the year. Whilst the Construction Industries segment should see sustained demand growth as the sector experiences an acceleration in growth over the coming 18 months, the Energy & Transport and Resource Industries segments are likely to see a more mixed growth outlook. With commodity prices remaining volatile and unlikely to see sustained price growth, companies are cautious in expanding capital expenditure, limiting demand growth for new equipment. In particular, high growth rates in the Resources segment (which expanded 18% y-o-y in H1), are correlated to base effects following a USD15.4bn reduction in segment revenues (as of end 2016) from a peak of USD21.2bn in 2012.
Over a multi-year horizon, Caterpillar's competitive positioning will be dependent on its ability progress on its targets to enhance the technological capacity of its assets. With the company highlighting this as a key strategic goal in the results release, Caterpillar is seeking to tap into growing demand from heavy industry companies to improve efficiencies and productivity on project sites through improved data connectivity and integration of equipment into worksite management tools.
|Growing From A Low Base|
|Caterpillar Sales And Revenues, USDbn, Including 2017 Estimate|
|2017 e =Caterpillar estimate. Estimated y-o-y Revenue Growth By Segment. Source: Caterpillar|
Construction: Sustainable Revenue Growth
The Construction Industries segment holds the greatest potential to drive sustained revenue growth for Caterpillar over the coming 18 months. We expect the global construction industry value to accelerate again in 2018 in real terms, supported by a combination of growing public and private finance for the sector and aided by a stabilisation and gradual increase in commodity prices which will allow companies and governments to expand investment following several years of cuts ( see, ' Global Infrastructure: Project Pipeline Progress Drives Growth Acceleration ' , 11 May 2017). We have seen this evidenced by a progression in the global project pipeline, with the value of projects in the 'In Tender' and 'Contract Award' phases up 50% and 33% respectively over the last year, according to BMI's Key Projects Database. This in turn indicates sustained expansion in demand for construction equipment, as projects move into the development phase and companies see project backlogs expand again.
|Growth Uptick To Support Equipment Demand|
|Construction Industry Value, Real Growth, % y-o-y|
|f=BMI forecast, Source: National Statistics, BMI|
Construction industry value growth in Asia in particular will remain strong through to the end of 2018, supporting sustained revenue growth for Caterpillar's Construction Industries segment in the region. Growth in Chinese demand for construction equipment was a central support to the company's 33% y-o-y revenue growth for the segment in Asia in H1 2017. China will be a key area of revenue generation, with fixed asset investment expected to remain elevated as infrastructure investment in particular is ramped up in line with the 13 th Five Year Plan (FYP) and efforts to stimulate the economy ahead of the Party Congress. Visibility on investment beyond the Party Congress is limited; however with the FYP covering the 2016-2020 period, infrastructure is likely to remain a key policy goal.
North America will likely see an expansion in construction equipment demand over the coming quarters from a relatively weak rate of revenue expansion seen in H117. In the US, the construction industry will remain supported by the residential building segment, and although we are not anticipating any progress on President Trump's infrastructure plan, we are expecting an uptick in state and local transport spending in select states including New York and California, providing pockets of growth in equipment demand. In Canada, early signs that the Liberal Government's stimulus plan is supporting construction activity are visible.
|Revenue Growth To Continue|
|Caterpillar Construction Industries Revenue, % Chg y-o-y|
|Source: Caterpillar, Bloomberg|
With Asia and North America accounting for almost two thirds of Caterpillar's revenues in the Construction Industries segment, strong growth outlooks should support sustained revenue growth in the segment. However, a less optimistic outlook for other regions presents a headwind to the high growth rates experienced by the segment in H1 2017.
In particular, a recovery in Latin American demand for equipment - as evidenced by the 31% growth in revenues from the region in Q217 - is mostly reflective of base effects rather than any sustained market strength. Latin America will remain our construction industry value growth laggard globally through to 2018, with Brazil's construction sector in particular seeing only limited signs of growth. Likewise, Europe, Middle East and Africa will continue to see only a mixed growth outlook. Whilst activity remains strong in Northern Europe supported by major government infrastructure investment plans, Southern, Central and Eastern Europe will see muted construction industry value growth owing to weak investment climates and delayed EU funding. MENA and SSA will be growth outperformers over a five year horizon, although remaining relatively small in scale compared to other regions. Through to 2018, however, both regions will continue to struggle with lower commodity prices, especially oil - creating an uneven demand picture for equipment. In particular we highlight weakness in Saudi over coming quarters as indicative of countries continuing to rationalise their spending priorities.
Resource Industries: Slow Down As Base Effects Wear Off
The significant growth in Caterpillar's Resource Industries segment in revenue terms (up 18% y-o-y in H1) is a reflection of the low base from which the segment is starting rather than a sustained recovery in the mining segment, signalling that high growth rates are unlikely to be maintained. The majority of revenue growth is related to aftermarket parts sales - indicative of an industry that is still not making major investment decisions that warrant large scale new machine purchases. Indeed, the average age of assets for major mining companies has increased notably in recent years symptomatic of the lack of capital and appetite to develop new resource bases. With commodity prices remaining volatile and price growth slowing or in some cases expected to reverse in 2018, companies are maintaining their low cost strategies. Instead, expansion of existing projects will remain the main focus as mining companies slowly expand their capital expenditures. Following several years of slashing investment, we expect 2018 could be the first year of growth in capital expenditure since 2013; however, spending levels will remain far below peaks over the next several years.
|Price Gains Only Partially Sustainable|
|Select Commodity Prices, % Change y-o-y|
|e/f=BMI estimate/forecast, Source: BMI, Bloomberg|
Given the low base of revenues following several years of steep declines in the segment - down USD15.4bn between 2012 and 2016 - there remain bright spots in the global mining sector which should support sustained revenue expansion in key growth markets. Mining investment is expected to target Asia and Africa, with these regions hosting the most new projects relative to existing operations, supported by the availability of high ore grades, low labour costs and outbound Chinese and Indian investment.
|Low Base Supports Growth|
|Resource Industries Revenues, USDbn|
Energy & Transportation: Uneven Growth
Demand for equipment from the energy segment will remain uneven over the coming quarters, in line with oil price volatility and uncertainty as the OPEC production cap expires in 2018. Although we see pockets of growth globally, with 50% of revenue for the segment coming from North America, slowing US demand will impact top line gains.
We expect a slowdown in the US energy equipment market in over the next 18 months. Caterpillar has benefitted from strong demand for natural gas compression equipment in the US, supported by growing exports of US natural gas as LNG facilities are coming online in addition to an expansion in drilling activity in unconventional acreage, focused primarily on the Permian. Whilst the former will remain an area of growth for the company, demand for the latter is expect to weaken in line with a stagnation in the rig count and a pull back in investment into drilling owing to a backlog of drilled but uncompleted wells, offsetting gains for the Energy & Transportation segment in the second half of the year.
|Recovery To Stagnate|
|US Oil & Gas Rig Count|
|Source: Baker Hughes, Bloomberg|
We expect Latin America to remain a growth market for energy equipment, although at just 10% of segment revenues and following sharp revenue declines in recent years, this will not have a major impact on the segment's top line. Oil price stabilisation on average over recent quarters has seen National Oil Companies (NOCs) in the region recalibrate spending plans and focus in on upstream production through expanding drilling activity, resulting in a marginal expansion in spending, albeit from a very low base. In particular, Brazil, Colombia and Argentina are all likely to present continued growth opportunities, as will Mexico overly a slightly longer time horizon as private investment starts to filter through to activity.
|Diverging Growth Outlook|
|Energy & Transportation Revenue, USDmn, Latin America & North America|
|Source: Caterpillar, Bloomberg|
Long Term Growth Prospects: Technology At The Centre
Initiatives outlined by Caterpillar to increase expenditure on research and development bode well for a company which has struggled to generate new areas of revenues. Over recent years, the strategic focus on cost cutting epitomised by the 'lean' strategy, has stabilised the company through a period of weak demand, but has done little to drive new areas of revenue generation. In particular, the company will expand expenditure into research and development with a focus on technology and data. Caterpillar already has the largest 'connected' industrial fleet globally (at 530,000 assets), and is hoping to grow this by 100,000 by the end of 2017. This focus aligns with the evolving demands of heavy industries companies, who in an era of sustained lower commodity prices are seeking efficiency and productivity gains - and are willing to expend significant capital to do so.
With developments progressing rapidly in this field, we expect Caterpillar could seek to acquire technology, leveraging its healthy balance sheet in order to compete with other major equipment producers who are pursuing the same strategy. Komatsu for example, Caterpillar's major competitor, launched its Smart Construction platform, which integrates drone and GPS technology to streamline processes at job sites. Caterpillar has indicated that inorganic growth is a strategic path for them, with several acquisitions in the data area over recent years, including M2M Data Corporation which specialises in monitoring and remote diagnostics of oil and gas assets, and ESRG Technologies Group, a vessel monitoring company specialising in the marine sector.