Tuesday, July 21, 2009

Caterpillar (CAT) and Freeport McMoran Copper & Gold (FCX) Please the Street

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We have a plethora of earning reports to get through [Early Week Earnings Watch] the next 72 hours, so we'll begin with Caterpillar (CAT) and Freeport McMoran Copper & Gold (FCX) - the former used as a proxy on global growth in terms of heavy construction equipment sales and the latter due to its heavy reliance on copper. As we've been saying FCX has seemingly replaced oil as this year's "go to" reflation trade stock. Both names are up this morning with a (cough) "surprise" beat by CAT (let me guess, revenue dropped like a rock, stabilization seen, China is the reason); again this only shows the analysts are completely unable to estimate the cost savings of slashing thousands of workers. Year over year results are dismal but on the Street all that matter is you "beat expectations"; heck sometimes stocks go up even when you don't beat expectations as long as you tell us soothing words like "stabilization" and "green shoots".

Let's look at these 2 closer, we'll spend more time on CAT since FCX is a simple story - copper prices = up, CEO is a genius lauded by infotaintment TV as a steward of strength and genius. Copper prices = down, horrific stock, who wants to own this sort of laggard?! Since the Chinese are buying copper like it is going out of style, [Mar 23: FT.com - Chinese Stockpiling Spurs Copper Price Rally] FCX gets the benefit.

CAT

Via AP
  • Caterpillar Inc., the world's largest maker of construction and mining equipment, said Tuesday its second-quarter profit tumbled 66 percent as the recession continued to erode sales of its machines and engines. But the company boosted its 2009 profit forecast, saying it is seeing signs of stabilization (ah the magic word in the CEO handbook, time to buy stock!) it hopes will lead to economic recovery.
  • It also sees indications that government stimulus plans, particularly in China, "are beginning to work." (don't forget France)
  • Sales of Caterpillar’s machinery fell in every region, including a 51 percent drop in North America, 61 percent in the region that includes Europe, 47 percent in Latin America and 25 percent in Asia-Pacific.
  • The Peoria, Ill.-based company, a component of the Dow Jones Industrial Average, said its quarterly profit slid to $371 million, or 60 cents per share, for the three months ended June 30. That compares with $1.11 billion, or $1.74 per share, in the year-earlier period.
  • Revenue dropped 41 percent to $7.98 billion, led by a 43-percent decline in equipment and engine sales.
Now again this is why almost all stocks are more expensive then they appear - in America we exclude certain costs that we call non-recurring. They don't count... our profits don't include them. Because they didn't really happen - at least now when we want to create the "E" in P/E ratio. So all those workers Caterpillar cut? Free pass - it doesn't count.
  • Excluding costs related to job cuts, Caterpillar earned 72 cents per share.
So we'll all clap at the 72 cents instead the actual profit of 60 cents, because those 12 cents related to chopping heads... not going to count in our pseudo make believe world of profit making on Wall Street. (I love the wording by CAT - "redundancy costs" Redundancy costs were $85 million before tax or $0.12 per share in the quarter.)
  • Caterpillar has undertaken dramatic cost-cutting measures, including the planned elimination of more than 22,000 positions and sweeping production cuts.
  • More than 17,000 contract and temporary workers also were cut.
Again, just ignore that fact - $85 million doesn't count against CAT as a cost when we look at profitability. All part of the wink wink game amongst the Street so we can claim how cheap the market is. Otherwise the stock market would be much more expensive if we actually included "1x" costs and it we'd see how little progress we've really made over the years in increasing actual value of public corporations.
  • Analysts surveyed by Thomson Reuters, on average, had expected earnings of 22 cents per share on revenue of $8.86 billion. Those estimates typically exclude one-time items.
That miss by the analysts is even more impressive considering Caterpillar missed on revenues, yet smashed earnings guestimates. I don't think analysts understand how powerful it is to the bottom line to cut thousands of heads. Especially when the costs of cutting of said heads doesn't even count on Wall Street.

Another 14 cents of earnings came out of the heavens via an inventory adjustment which created a 14 cent benefit. Of course that *IS* included even though it is 1x in nature.
  • Inventory has been reduced by $1.621 billion from December 2008. The significant inventory reduction has resulted in pre-tax LIFO inventory decrement benefits of $110 million or $0.14 per share in the quarter.
So this is why I am say to readers, the bottom line profits ("earnings") in American accounting / Wall Street estimates is more art than science - so much "gray area" and "exclusions" when it's a cost but "inclusions" when its a benefit. And since almost no investor now takes the time to actually read a press release and instead acts immediately to the CNBC breaking news or Reuters headline - we all rush in and out of stocks based on that alone. The details are ... well, just details. The truth lies in the revenue line which unless you are Enron is one thing you cannot "adjust" through a series of 1x adjustments. Analysts expected $8.9 billion, CAT came in at $7.9 billion.

All that said, that is just between you and me. If the majority just knee jerk react in lemming like nature to the headline without ever looking beneath the hood, so must you. Otherwise you feel intellectually smart, but don't make money in our stock markets. So in a backwards way, the more you dig, the less profit you make in the A.D.D., video game, instantaneous program trading casino we've created. Just go with the crowd young man - they are always 'right'.

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As for the all important forecast...
  • ...the heavy equipment maker increased its 2009 profit expectations to between $1.15 and $2.25 per share despite "a great deal of economic uncertainty." It previously forecast about $1.25 per share. Analysts predicted $1.01 per share.
  • There is still a great deal of economic uncertainty in the world," said company Chairman and Chief Executive Jim Owens in a statement. "But we are seeing signs of stabilization. ... Credit markets have improved significantly. Fiscal policy and monetary stimulus have been introduced around the world, and we are seeing signs, particularly in China, that they are beginning to work."
Now again that profit estimate is when you do NOT include redundancy costs - i.e. the tens of thousands of humans chopped.
  • We expect 2009 profit in a range of $0.40 to $1.50 per share including redundancy costs of about $700 million, or $0.75 per share. Excluding redundancy costs, we expect profit to be between $1.15 and $2.25 per share.
If you did include those costs profits would be in a range of $0.40 to $1.50. The seals would not be clapping quite so loudly. (p.s. I don't have an issue with the cutting of jobs, if that is necessary to run the company. My issue is with the white lies buried in our accounting reports to fluff up how "well" things are going, across the stratosphere of US companies)

Aside from that minor detail, the cool thing about being a bull is when Caterpillar lowered guidance last quarter you could IGNORE it and say what does the CEO know, I am forecasting a recovery in 3-6 months - CAT is an early cycle recovery stock and it's time to buy. No matter what they say. And now when the CEO raises guidance back to where it was before he lowered it 3 months ago, you can smile breathlessly and say "wow I am so surprised", and you can buy stock again. See how it works? Reduced guidance = ignore it. Raised guidance = joy. Sort of like the bad economic data ... if its bad go on infotainment TV and say "backwards looking". Yet if its good it somehow is NOT backwards looking, it is "green shoots" and a "sign of stabilization". Funny how that works. But when 95% of the Street is involved in selling you on how great the water is ("come on in!") I guess that's just the way it works. ;) Full report here.

And there we go, in just over a week one of the blue chip, staid companies just rallied 33%+.

FCX

Onward to the less convuluted story at Freeport - again, much like an oil production company when oil prices rise, everyone lauds the company and the results are "awesome". And vice versa. Since China has come through - driving copper up significantly, it's time to laud the executive team for a job well done. And give them more bonuses.

Via AP
  • Freeport-McMoRan Copper & Gold Inc. on Tuesday said its second-quarter profit dropped 38 percent, largely because of weak copper sales in North America.
but....!
  • The Phoenix-based company, the world's largest publicly traded copper company, beat analyst expectations (oooh) and raised its full-year consolidated sales estimates (aah), boosting shares in premarket trading.
  • Quarterly earnings fell to $588 million, or $1.38 per share, compared with $947 million, or $2.25 per share. Analysts surveyed by Thomson Reuters forecast a profit of 69 cents a share.
  • Revenue fell 32 percent to $3.68 billion, down from $5.44 billion in the prior-year period. Analysts forecast revenue of $3.4 billion, on average.
At least they beat the revenue estimate unlike 75% of the companies out there. But again, this is exactly the type of sector where the cries for CEO pay as "just" are quite silly. There is very little control the executive team is going to have when (insert commodity of choice) rises or drops 30,40,50% in a year.

So where did we see strength if North America stunk? Wait for it...
  • Global demand for copper surpassed prior-year levels, strengthened by increased activity in China and other emerging markets. However, the U.S. housing market, which uses copper for wiring and pipes, showed little improvement. (I thought we saw green shoots everywhere in the housing market - please don't tell me that is a infotainment financial TV mirage)
  • Consolidated copper sales rose to 1.1 billion pounds, compared with 942 million pounds in the prior-year period. Better demand was tempered by a lower average realized price per pound compared with last year. For instance, in North America the average price was $2.18 per pound, down from $3.82 per pound last year.
And that's the depth of the report - again, it's not a very complicated business... pull X out of ground, sell X on market, thank the stock gods that China needs copper, collect massive stock options and gains, while backslapping with board of directors. Than extol how only you and a few others on the planet have the skill set to run such a complicated operation; and the free market (i.e. generally a group of other C level executives or retired politicians sitting on your board) sets your pay. Magic.
  • During the second quarter, copper prices rose about 22 percent from $1.86 to $2.27 per pound.
Oops, I did forget to say - the 1x costs of cutting heads were again excluded ... remember, "redundancy" doesn't count in American accounting.
  • The net income figure, which excluded unrealized gains and restructuring charges, matched the consensus analyst estimate of 72 cents, according to Reuters Estimates.
Via Reuters...
  • In June, (CEO) Adkerson told Reuters there was no sign of recovery in the developed world that would lead to a restart of its idled U.S. copper operations, despite a pick-up in Chinese buying.
  • To bring back its Morenci, Arizona, copper mine, now running at 50 percent of capacity, to full bore, he said there would be "no single trigger."
Apparently Adkerson does not watch CNBC enough... green shoots are everywhere sir. Please open those Arizona mines and put American workers... err "the redundants".... back to work.

Full report here.


United Technology (UTX) is another excellent company to review to figure out what is really going out there in the world, one of the best run companies in the world. I won't break it out separately but worth a read if you prefer to dig for yourself and not be captured by financial infotainment TeeVee. One snippet:
  • “The rate of decline in orders across the businesses appears to have stabilized, although orders remain lower than previously anticipated,” Chenevert, 52, said in the statement. The company doesn’t foresee any economic improvement in 2010 with the possible exception of China.
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