A difficult macroeconomic environment is culling Caterpillar (CAT) stock's outlook for 2019.
Shares of the Peoria, Illinois-based construction and materials company fell by their largest margin in a decade in afternoon trading after a disappointing earnings release on Monday morning.
Shares were down nearly 9% to $124.72 as of 2:45 p.m. ET.
The company blamed Latin American and, of course, Chinese results for offsetting the gains made in domestic markets and promoting the significant earnings per share miss in the fourth quarter that was followed by weak guidance.
"Latin America is expected to continue its recovery but demand will remain at relatively low levels. In the Europe, Africa, Middle East region, demand remains steady but political and economic uncertainties exist," CFO Andrew Bonfeld told analysts. "Positive price realization was offset by higher manufacturing costs, largely due to higher material and freight costs, as steel prices, tariffs, and supply chain inefficiencies continued to impact our results."
The signal of demand slowdowns adds to the impact from China that was touted by CEO Jim Umpleby in the company's prepared statements.
A major issue for Caterpillar was and continues to be China as the company finds itself hit by steel tariffs and supply chain impacts as well as slowing sales amid a Chinese economic slowdown.
Action Alerts PLUS portfolio manager Jim Cramer commented that China was the key effect on the weak print Monday morning that has promoted the plunge in share price.
"I think Caterpillar was surprised at how weak China was," he said. "Caterpillar shows you what happens in a worldwide slowdown."
In line with the disappointment, management was conservative on its forecast in the region for 2019.
Executives spoke to this difficulty, noting that the fluid situation is making forecasting an uncertain prospect.
"Within China, the industry is very dynamic and there are a variety of forecasts," Bonfeld explained. "We will continue to monitor the situation but as of now we are forecasting the overall China market to be roughly flat in 2019 following two years of significant growth."
He added that China represents about 10% to 15% of our total construction industry sales for the company and about 5% to 10% of total Caterpillar sales and revenue. The numbers make China the largest non-North American market for the company.
An enduring trade war would certainly continue to temper results for the company.
Still, Bonfeld said that rate increases on tariffs are not expected and should help normalize results.
Umpleby added that the company is in a good position to deal with both a more belligerent trade situation and a potential market downturn, should that occur.
"We'll continue to closely monitor costs and we'll always be ready for whatever the market sends us. One of the things we believe we're in much better shape," he explained. "At some point there will be a market downturn. We're not calling that in 2019. Whenever that does occur, we're certainly in a better position to generate cash than we were in the last downturn. We'll be very cost disciplined here moving forward."
The company's capital discipline is allowing for Caterpillar to continue in its typical dividend increasing habit and pursue share repurchases at depressed levels.
Nonetheless, it will likely take a substantive shift in trade negotiations to help coax shares out of their cratered levels.
Lagging in Latin America
Latin America was also noted as a significant challenge for the company as slower spending in the region tamped down results and future expectations.
"Several South and Latin American countries continue to experience economic challenges," Bonfeld said. "Sales were down $18 million or about 5% for the region."
The trend is problematic for Caterpillar as Brazil is one of the company's largest geographical segments.
Executives noted their disappointment with the market and its deceleration, singlign out two of the largest markets as increasing in difficulty given the decreased incentives and economic situation.
"Brazil has been tough, Argentina's been tough," Bonfeld said while listing out countries that have encountered issues, adding South Africa and Turkey to the list outside Latin America.
Further, Latin America contributed to problems in the Cat Power Finance division as past-due loans added to risks and prompted reduced numbers in retail new business volume.
"Financial Products were unfavorable by $141 million largely due to the absence of gains from the sale of securities, unfavorable impacts from the move to mark-to-market accounting of equity securities and weakness in the Cat power finance and Latin American portfolios," Bonfeld said.
Analysts expressed concern on this end, asking questions of Bonfeld as to the effect of this business on outlook.
"Within the FinCo, Cat Power finance continued to soften - past dues were 3.55%, up from 2.78% year over year and new business volume was down 9% mainly due to power," Deutsche Bank analyst Chad Dillard noted.
Still, Dave Walton, president of Cat Financial, explained that the company remains confident in this segment moving forward despite the visible weakness.
"Despite the decrease in profit from continued weakness in Cat Power Finance and Latin America portfolios, we are pleased with the overall performance of our core asset portfolio and the portfolio growth achieved in 2018," he said.
For now, the market is none to pleased at all and is happy to take shares down significantly and temper estimates for the market overall as signs of a slowing global economic environment begin to show.
Caterpillar alone has helped shave almost 100 points off the Dow in afternoon trading and is leading peers like Deere & Co. (DE) and Terex Corporation (TEX) notably downward ahead of their own earnings releases in February.