Strategic Analysis: Caterpillar Inc.

1.      Introduction

1.1  Corporate Profile: Caterpillar Inc

Caterpillar Inc is “the world’s leading manufacturer of construction and mining equipment, diesel and natural gas engines, industrial gas turbines, and diesel-electric locomotives” (Caterpillar 1). It operates two main segments: Machinery, Energy, & Transportation segment and Financial Products segment.

Under Machinery, Energy, & Transportation segment, it has three main sub-segments: Construction Industries, $15.6 billion; Resource Industries, $5.7 billion; and Energy & Transportation, $14.4 billion (Caterpillar 29). The segment generated consolidated revenue totaling $35.8 billion (excluding eliminations) in fiscal 2016 (Caterpillar 29).

Financial Products segment generated $2.8 billion (excluding corporate eliminations) in fiscal 2016 (Caterpillar 29). The group had $38.5 billion in consolidated sales and revenues and posted a net loss of $59 million (Caterpillar 70). The bulk of group’s business representing 46.6% of consolidated revenue is undertaken in North America.

2.      Financial Analysis

Financial analysis “involves the selection, evaluation, and interpretation of financial data and other pertinent information to assist in evaluating operating performance and financial condition of a company” (Drake and Fabozzi 243). Some of the tools involved include ratios analysis as well as evaluation of individual financial statements like income statement.

2.1  Income Statement

The income statement outlines the “firm’s revenues and expenses over a period of time” (Berk and DeMarzo 28). In fiscal 2016, total sales and revenues decreased by 18.0% from $47.0 billion in fiscal 2015 to $38.5 billion (Caterpillar 70). Total operating costs reduced by 12.0% from $43.2 billion in fiscal 2015 to $38.0 billion in fiscal 2016 (Caterpillar 70).

Caterpillar achieved gross profit of $9.6 billion in fiscal 2016 compared to $12.9 billion in fiscal 2015 which was reduction of 25.2% year-over-year (Yahoo Finance para.2). The lower level of gross profit was largely driven by higher reduction of 18.0% in total sales and revenues compared to a reduction of 15.3% in cost of goods sold.

Total sales and revenues declined at a greater pace than total operating costs. The difference of 6.0% impacted operating profit performance. It declined by 86.8% from $3.8 billion in fiscal 2015 to $498 million in fiscal 2016 (Caterpillar 70). Consolidated profit before tax also declined significantly after deducting interest expenses.

The massive reduction in consolidated sales was largely due to weakness in commodity prices as well as general global economic weakness. It meant that sales were weak across all operating segments. There was marginal change in total operating expenses except for reduction in cost of goods sold and goodwill impairment charge that was included in fiscal 2016.

It resulted in lower decrease in total operating expenses compared to the reduction in total sales and revenue. There was marginal change in interest expenses and other income which resulted in 95.9% decline in profit before taxes. After deducting provision of taxes of $192 million, the group achieved a net loss after tax of 53 million (Caterpillar 70).

2.2  Statement of Cash Flow

The statement of cash flows “utilizes information from the income statement and balance sheet to determine how much cash the firm has generated, and how that cash has been allocated, during a set period” (Berk and DeMarzo 31). The major items are: cash flow from operating activities, cash flow from investment activities, and cash flow from financing activities.

Total cash flow from operating activities decreased by 16.0% year-over-year in fiscal 2016 which was also lower by 17.2% compared to fiscal 2014 (Yahoo Finance para.4). There was significant change in net income impacting on cash flow generated from operating activities. However, there was a reduction in liabilities and increase in inventory that boosted income.

There was cumulative reduction of 51.5% in total cash flow used in investment activities from fiscal 2014 (Yahoo Finance para.4). Capital expenditure increased while additions to finance receivables were cancelled by collections from finance receivables. There was modest increase in investment which resulted in overall decrease in cash flow used in investment.

Total cash flow used in financing activities decreased by 19.6% in fiscal 2016 compared to fiscal 2015 but was higher by 3.9% in fiscal 2016 when compared to fiscal 2014 (Yahoo Finance para.4). There was an increase in dividends paid, increase in net borrowings, and significant reduction in purchase of stock resulting in low financing costs.

The effect of exchange rate differences was lower in fiscal 2016 at a loss of $28 million compared to a loss of $169 million and $174 million in fiscal 2015 and 2014 respectively (Caterpillar 75). The net impact was an increase in cash and cash equivalents of $708 million in fiscal 2016 compared to a decrease of $881 million in fiscal 2015 (Caterpillar 75).

2.3  Financial Ratios

Financial ratios make comparison between different bits of financial information (Drake and Fabozzi 244). The main financial ratios that assess the operating performance and financial conditions of firms are: liquidity ratios, asset management (activity) ratios, debt (financial leverage) ratios, and profitability ratios (Drake and Fabozzi 245).

2.3.1  Liquidity Ratios

Liquidity ratios compare short-term liquidity by utilizing assets that are readily convertible into cash relatively easily (Drake and Fabozzi 247). Current ratio compares current assets to current liabilities. Caterpillar Inc’s current ratios were 1.31 and 1.22 in fiscal 2015 and fiscal 2016 respectively compared to 2.13 and 2.06 for Deere & Company.

It implied that in fiscal 2016, Caterpillar Inc had $1.22 in current assets compared to every $1.00 in current liabilities; a ratio of 1.22:1. It was a reduction compared to 1.31 in fiscal 2015 largely due to lower inventories. The main competitor, Deere & Company had significantly higher current ratios at 2.06: 1 in fiscal 2015 and 2.13: 1 in fiscal 2016.

Quick ratio excludes inventories (considered as the most illiquid current assets) in the computation that is similar to current ratio (Drake and Fabozzi 251). Caterpillar Inc had quick ratios of 0.84:1 in fiscal 2015 and 0.83:1 in fiscal 2016 compared to Deere & Company’s 1.88:1 in fiscal 2015 and 1.95:1 in fiscal 2016 implying that Caterpillar Inc is underleveraged.

Essentially, Caterpillar Inc had $0.83 in current assets (excluding inventories) compared to every $1.00 in current liabilities. However, Deere & Company had a higher level of current assets compared to current liabilities. Caterpillar Inc’s leverage is below the theoretical minimum of 1:1 that is recommended but it is only considered as a guide (Dyson 223).

2.3.2  Asset Management Ratios

Asset management ratios are considered as activity or efficiency ratios that indicate the benefits from specific assets or entirety of total assets (Drake and Fabozzi 255). Inventory turnover compares the rate of conversion of inventory into goods that are sold. Caterpillar Inc had inventory turnover of 3.08 and 3.09 in fiscal 2015 and fiscal 2016 respectively.

Comparatively, Deere & Company had inventory turnovers of 5.06 and 5.14 over a similar fiscal period. The implication was that in fiscal 2016, cash conversion from inventory to sales occurred 3.09 times at Caterpillar Inc compared to Deere & Company’s 5.14 times. In essence, Caterpillar Inc underperformed Deere & Company in both fiscal years.

Asset turnover illustrates the number of times that the firm’s value of total assets is generated in revenues (Drake and Fabozzi 257). Caterpillar Inc’s asset turnovers were 0.58 and 0.50 in fiscal 2015 and fiscal 2016 compared to Deere & Company’s 0.48 and 0.46 over the same period. In 2016, Caterpillar Inc generated $0.50 in revenue for every $1.00 in total assets.

2.3.3  Debt Ratios

Debt or financial leverage ratios assesses the financing position within the firm (Drake and Fabozzi 258). Debt/equity ratio measures “how the company finances its operations with debt relative to the book value of its shareholders’ equity” (Drake and Fabozzi 259). Caterpillar Inc had debt/equity ratios of 1.70 and 1.74 in fiscal 2015 and fiscal 2016 respectively.

Comparatively, Deere & Company had debt/equity levels of 3.53 and 3.64 respectively in fiscal 2015 and 2016. It implied in fiscal 2016 that Caterpillar Inc had $1.70 in debt for every $1.00 in shareholders’ equity. Thus, Deere & Company was comparatively overleveraged with respect to long-term solvency utilizing more debt relative to shareholders’ equity.

It had interest coverage of 7.78 in fiscal 2015 and 2.46 in fiscal 2016 compared to 5.09 and 3.91 for Deere & Company in fiscal 2015 and fiscal 2016 respectively. Generally, higher interest coverage is preferred (Drake and Fabozzi 260) which Caterpillar Inc had in fiscal 2015 while Deere & Company had better coverage of 3.91 times in fiscal 2016.

2.3.4  Profitability Ratios

Profitability ratios make an assessment of management’s ability to control expenses (Drake and Fabozzi 253). The net margin excludes all expenses including production, operating, and financing costs. Caterpillar Inc had net margins of 4.47% in fiscal 2015 and (0.17%) in fiscal 2016. The negative position in fiscal 2016 was due to a net loss during that year.

Comparatively, Deere & Company had net margins of 6.72% and 5.72% in fiscal 2015 and 2016 respectively. Therefore, Deere & Company outperformed Caterpillar Inc during both fiscal years. Return on Equity (ROE) and Return on Assets (ROA) are factors of net income and the high the net income, the higher ROEs and ROAs.

Thus, in fiscal 2016, the loss that was reported in net income resulted in negative position for ROE and ROA for Caterpillar Inc. Deere & Company had slight decline in net margin implying a reduction in net profit that also impacted its ROE and ROA. Generally, Deere & Company outperformed Caterpillar Inc in all the three measures.

3.      Company Analysis

3.1  Industry/Sector

 

3.2  Market Position

 

3.3  Market Share

 

3.4  Market Structure

 

 

 

 

4.      International Exposure

4.1  International Markets

 

4.2  Operating Model

 

4.3  Currency Issues

 

 

 

 

 

 

 

 

 

 

 

5.      Strategic Issues & Potential Solutions

5.1  Strategic Issues

 

5.2  Potential Solutions

 

 

 

 

 

 

 

 

 

 

 

 

 

Conclusion

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Works Cited

Berk, Jonathan, and Peter DeMarzo. Corporate Finance, 3rd Edition. Boston: Pearson Education, Inc. 2014. Print.

Caterpillar. Building Better: Caterpillar 2016 Annual Report. Peoria: Caterpillar Inc. 2017. Print.

Drake, Pamela Peterson and Frank, J. Fabozzi. The Basics of Finance: An Introduction to Financial Markets, Business Finance, and Portfolio Management. Hoboken: John Wiley & Sons. 2010. Print.

Dyson, John, R. Accounting for Non-Accounting Students, 8th Edition. Harlow; Pearson Education Limited. 2010. Print.

Morningstar. Caterpillar Inc, CAT: Key Ratios. Morningstar. 2017a. Web. 2017.

Morningstar. Deer & Co, DE: Key Ratios. Morningstar. 2017b. Web. 2017.

Yahoo Finance. “Caterpillar Inc. (CAT): Financials: Income Statement”. Yahoo Finance. 2017a. Web. 19 June 2017.

Yahoo Finance. “Caterpillar Inc. (CAT): Financials: Cash Flow”. Yahoo Finance. 2017a. Web. 19 June 2017.

 

 

 

 

Appendix

Figure 1: Comparative Financial Ratios: Caterpillar Inc and Deere & Company

  Caterpillar Inc. Deere & Company
  2016 2015 2016 2015
Liquidity
Current Ratio

Quick Ratio

1.22

0.83

1.31

0.84

2.13

1.95

2.06

1.88

Asset Management
Inventory Turnover

Asset Turnover

3.09

0.50

3.08

0.58

5.14

0.46

5.06

0.48

Debt (Financial Leverage)
Debt/Equity

Interest Coverage

1.74

2.46

1.70

7.78

3.64

3.91

3.53

5.09

Profitability
Net Margin

Return on Equity (ROE)

Return on Assets (ROA)

(0.17%)

(0.48%)

(0.09%)

4.47%

13.32%

2.58%

5.72%

22.97%

2.63%

6.72%

24.54%

3.25%

 

Source: Morningstar (para.1) and Morningstar (para.2)

 

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