Amazon and Apple made headlines on Thursday after reporting their first-quarter 2022 earnings -- which largely overshadowed Caterpillar's (NYSE: CAT) earnings report. However, industrial bellwether Caterpillar's results can provide insight into the pulse of the global economy, especially considering that over half of Caterpillar's sales come from outside of North America.
Here's what Caterpillar just told us about the economy and what it could mean for your investment portfolio, even if you aren't interested in Caterpillar stock specifically.
Image source: Getty Images.
Margins are under pressure
Caterpillar is optimistic that price increases will offset higher costs due to inflation. But it was clear that supply-chain constraints are far from over and that these challenges are impacting its profitability.
Segment | Q1 2022 | Q1 2021 | Year-Over-Year Change |
|---|---|---|---|
Construction Industries Revenue | $6.1 billion | $5.5 billion | 12% |
Construction Industries Profit | $1,057 million | $1,042 million | 1% |
Construction Industries Profit Margin | 17.3% | 19.1% | (1.8 percentage points) |
Energy & Transportation Revenue | $5 billion | $4.5 billion | 12% |
Energy & Transportation Profit | $538 million | $675 million | (20%) |
Energy & Transportation Profit Margin | 10.7% | 15% | (4.3 percentage points) |
Resources Industries Revenue | $2.8 billion | $2.2 billion | 30% |
Resources Industries Profit | $361 million | $312 million | 16% |
Resources Industries Profit Margin | 12.8% | 14.3% | (1.5 percentage points) |
Financial Products Revenue | $783 million | $761 million | 3% |
Financial Products Profit | $238 million | $244 million | (2%) |
Financial Products Profit Margin | 30.4% | 32.1% | (1.7 percentage points) |
Total Revenue | $13.6 billion | $11.9 billion | 14% |
Total Profit Per Share | $2.86 | $2.77 | 3% |
Overall Profit Margin | 13.7% | 15.3% | (1.6 percentage points) per share |
Data source: Caterpillar. Chart by author.
Although Caterpillar's Q1 2022 revenue was 14% higher than Q1 2021, profit per share was only 3% higher. Probably the most glaring takeaway is that all three of Caterpillar's business segments and its financial products business unit suffered profit margin declines. That is troubling news considering how hot the construction, oil and gas, rail, marine, agriculture, and mining industries are right now.
It is also surprising to see Caterpillar's energy and transportation segment post a mere 12% increase in revenue and book 20% less profit than a year ago, given that oil and gas prices have substantially increased over that time frame.
In fact, if we dig into the numbers, we find that oil and gas generated just $948 million in Q1 2022 revenue, only 4% higher than Q1 2021, while power generation generated just 5% year-over-year revenue in Q1 2022. This low growth and margin pressure could signify that demand growth isn't high enough to support earnings growth.
Impact on the broader economy
Caterpillar's poor, overall results indicate that capital investment in construction and energy and transportation may be lower than it had hoped. Put another way, it doesn't seem that Caterpillar's customers are reacting to strong performances in their industries by boosting purchases of new equipment a great deal.
If this theme plays out in the rest of the economy, it could mean that the industrial and energy sectors, as a whole, are keeping a lid on spending in anticipation of an economic slowdown.
A downturn in its China construction business
Another disconcerting line item from Caterpillar's report was its 21% revenue decrease in Asia/Pacific construction sales -- largely due to a slowdown in demand out of China. Asia/Pacific construction sales are a major part of Caterpillar's business -- accounting for nearly 8% of its total sales. Seeing demand slow out of China could be partially due to COVID-19 lockdowns. But given that China is Caterpillar's fastest-growing market, it does not do the company any favors to now see China as its worst geographic segment.
Negative free cash flow
Caterpillar reported negative $400 million in machinery, energy, and transportation (ME&T) free cash flow (FCF) compared to a gain of $1.7 billion in Q1 2021. The loss was largely due to $1.3 billion in short-term incentive compensation, a program that was reinstated in 2021.
Caterpillar repurchased $800 million in common stock and paid $600 million in dividends. But given that it didn't produce positive FCF, those obligations impacted its cash position. Caterpillar's cash balance fell by $2.7 billion compared to Q4 2021 and is now just $6.5 billion. The industrial company also cited higher research and development costs and sales, general, and administrative expenses as reasons for its cash burn.
Where to go from here
Caterpillar is spending more money on its operations due to higher costs, investing more in its long-term growth, and paying employees higher incentives. These measures are taking a sledgehammer to its margins and moving it further away from the coiled spring that some investors hoped would pop in response to a booming economy.
Caterpillar's numbers inform investors about the extent of inflation in the industrial economy, even for industries that are doing well right now. Caterpillar's performance also tells us that demand and capital expenditures for end customers may not be as high as some hoped they would be. These are red flags for the short-term outlook of the economy.
The silver lining is that Caterpillar has been through plenty of economic cycles before and has proven time and time again that it can persevere. Caterpillar is a Dividend Aristocrat that has paid and raised its dividend for 27 consecutive years, providing a passive income stream for long-term investors as they ride out this choppy outlook.
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