Caterpillar Q3 2023 Earnings Call Transcript

There are 13 speakers on the call.

Operator

Ladies and gentlemen, welcome to the Third Quarter 2023 Caterpillar Earnings Conference Call. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Ryan Fiedler. Thank you, and please go ahead.

Speaker 1

Thanks, Abby. Good morning, everyone, and welcome to Caterpillar's Q3 of 2023 earnings call. I'm Ryan Fiedler, Vice President of Investor Relations. Joining me today are Jim Umpleby, Chairman and CEO Andrew Bonfield, Chief Financial Officer Kyle Eppley, Senior Vice President of the Global Finance Services Division and Rob Rangel, Senior IR Manager. During our call, we'll be discussing the Q3 earnings release we issued earlier today.

Speaker 1

You can find our slides, the news release webcast recap at investors. Caterpillar.com under Events and Presentations. The content of this call is protected by U. S. And international copyright law.

Speaker 1

Any rebroadcast, retransmission, reproduction or distribution of all or part of this content without Caterpillar's Prior written permission is prohibited. Moving to Slide 2. During our call today, we'll make forward looking statements, which are subject to risks and uncertainties. We'll also make assumptions that could cause our actual results to be different than the information we're sharing with you on this call. Please refer to our recent SEC filings and the forward looking statements reminder in the news release for details on factors that individually or in aggregate Could cause our actual results to vary materially from our forecast.

Speaker 1

A detailed discussion of our many factors that we believe may have a material effect On our business on an ongoing basis is contained in our SEC filings. On today's call, we'll also refer to non GAAP numbers. For a reconciliation of any non GAAP numbers to the appropriate U. S. GAAP numbers, please see the appendix of the earnings call slides.

Speaker 1

Now let's turn to Slide 3 and turn the call over to our Chairman and CEO, Jim Umbleby. Thanks, Ryan. Good morning, everyone. Thank you for joining us. Before discussing our results, I'd like to take a moment to acknowledge the tragic events in the Middle East.

Speaker 1

We are deeply saddened by the loss of life and are hopeful for a quick and peaceful resolution. The Caterpillar Foundation is donating $1,000,000 to the American Red Cross and its network of Red Crescent societies in the region to support the humanitarian needs of those impacted. As we close out the Q3, I want to thank our global team for delivering another strong quarter. This included double digit top line growth, Strong adjusted operating profit margin and robust ME and T free cash flow. Our results continue to reflect Healthy demand across most of our end markets for our products and services.

Speaker 1

We remain focused on executing our strategy And continue to invest for long term profitable growth. I'll begin with my perspectives about our performance in the quarter. I'll then provide some insights about our end markets. Lastly, I'll provide an update on our sustainability journey. Moving to quarterly results, it was another strong quarter.

Speaker 1

Sales and revenues increased 12% in the Q3 versus last year. Adjusted operating profit margin improved to 20.8%, Up significantly year over year, we also generated $2,900,000,000 of ME and T free cash flow in the quarter. Sales were generally in line with our expectations, while both adjusted operating profit margin and ME and T free cash flow in the 3rd quarter were better than we expected. In addition, we ended the quarter with a healthy backlog of $28,100,000,000 Backlog is a function of demand and lead times. As I've mentioned, demand remains healthy in most of our end markets.

Speaker 1

Due to improving supply chain conditions, product availability and lead times have proved for many products. Dealers and customers can wait longer to place orders, which has led to a moderation in order rates as expected. In addition, we have seen a reduction in dealer orders for building construction products, which we anticipated due to the changeover to CAT engines that we previously discussed And for excavation, in anticipation of dealers reducing their inventories in the Q4. Although our backlog decline is expected, It still remains elevated as a percentage of revenues compared to historic levels. While we continue to closely monitor global macroeconomic conditions, We now expect our full year 2023 results to be better than we anticipated during our last earnings call.

Speaker 1

Turning to slide 4. In the Q3 of 2023, sales and revenues increased by 12% to $16,800,000,000 driven primarily by favorable price realization as well as volume growth. Sales increased in each of our 3 primary segments. Compared with the Q3 of 2022, overall sales to users increased 13%, which was below our expectations. Energy and transportation sales to users increased 34%, but was lower than expected due to some supply chain challenges for large engines And the timing of gas turbine and international locomotive deliveries.

Speaker 1

For machines, which includes Construction Industries and Resource Industries, Sales to users rose by 7%, in line with expectations. Sales to users in construction industries were up 6%. North American sales to users increased as demand remained healthy for nonresidential and residential construction. Non residential continue to benefit from government related infrastructure and construction projects. Residential sales to users in North America Also increased in the quarter.

Speaker 1

EAME sales to users were up slightly, primarily due to continuing strength in Middle East construction activity. In Latin America and Asia Pacific, sales to users declined in the quarter. In Resource Industries, sales to users increased 10%. In mining, sales to users increased with commodities remaining above investment thresholds. Within heavy construction and quarry and aggregates, sales to users also increased, supported by growth for infrastructure related projects.

Speaker 1

In Energy and Transportation, sales to users increased by 34%. All applications saw higher sales to users in the quarter. Oil and Gas sales to users benefited from strong sales of turbines and turbine related services. We also saw continued Power generation sales to users continue to remain positive due to favorable market conditions, including strong data center growth. Industrial and transportation sales to users also increased.

Speaker 1

Dealer inventories increased by $600,000,000 in the quarter, Lead by Construction Industries and followed by Energy and Transportation. In Construction Industries, the increase was in North America and some of our most We remain very comfortable with the total level of dealer inventory, which is within the typical range. Andrew will provide more color later in the call. Adjusted operating profit margin increased 20.8% in the 3rd quarter, a 430 basis point increase over last year. Adjusted operating profit margin was better than we had anticipated.

Speaker 1

Relative to our expectations, we saw lower than expected manufacturing costs, including freight, as well as slightly favorable price realization, which included a positive impact from geographic mix. Moving to Slide 5. We generated strong ME and T free cash flow of $2,900,000,000 in the 3rd quarter $6,800,000,000 in the 1st 3 quarters of 2023. Year to date, We returned $4,100,000,000 to shareholders, which included about $2,200,000,000 in repurchase stock and $1,900,000,000 in dividends. We remain proud of our dividend aristocrat status and continue to expect to return substantially all ME and T free cash flow to shareholders over time through dividends and share repurchases.

Speaker 1

Now on Slide 6, I'll describe our expectations moving forward. As I mentioned earlier, we now anticipate the full year to be better than we previously expected. We expect our adjusted operating profit margin to be slightly above the target range relative to the corresponding level of sales. This positive operating performance increases our expectation for ME and T free cash flow, which we now expect will exceed the $4,000,000,000 to $8,000,000,000 target range for the full year. This outlook for the adjusted operating profit margin And ME and T free cash flow reflects healthy customer demand and our strong operating performance.

Speaker 1

Now, I'll discuss our outlook for key end markets, starting with Construction Industries. In North America, overall, we continue to see positive momentum. We expect continued growth in non residential construction in North America due to the impact of government related infrastructure investments and a healthy pipeline of construction projects. Although residential construction growth has moderated, we expect it to remain healthy. In Asia Pacific, excluding China, we expect growth in construction industries due to public infrastructure spending and support of commodity prices.

Speaker 1

As we have mentioned during previous earnings calls, we anticipate continued weakness in China and expect it to remain well below our typical range of 5% to 10% of enterprise sales. In EAME, We anticipate the region will be slightly down as weakness continues in Europe, partially offset by continuing strong construction demand in the Middle East. Construction activity in Latin America is expected to be about flat versus strong 2022 performance. In Resource Industries, we continue to see a high level of quoting In mining, customer product utilization remains high. The number of parked trucks remains low and the age of the fleet remains elevated.

Speaker 1

Order rates are slightly lower than we expected at this time, reflecting continued capital discipline by our customers. We continue to believe the energy transition will support increased commodity demand over time, expanding our total addressable market and providing further opportunities for long term profitable growth. In addition, customer acceptance of our autonomous solutions continues to grow. This is evidenced by the announcement this morning with Freeport McMoran, who will convert their fleet of Cat 793 Large Mining Trucks at an Arizona copper mine To autonomous haulage using Cat MineStar Command. We also expect heavy construction and quarry and aggregates to remain in healthy levels due to major infrastructure and non residential construction projects.

Speaker 1

Moving to energy and transportation. In oil and gas, we remain encouraged by continuing strong demand for CAT reciprocating engines and gas compression. As we said last quarter, Well servicing in North America is showing some short term moderation, but we remain optimistic about future demand. Cat reciprocating engine demand for power generation Is expected to remain strong, primarily driven by data center growth. New equipment and services for solar turbines in both oil and gas and power generation remain robust.

Speaker 1

Industrial demand is expected to soften slightly from recent high levels, but remains well above our historical averages. In transportation, we anticipate strength in high speed marine as customers continue to upgrade aging fleets. As we've described, we continue to see strength in most of our end markets. Based on our backlog, dealer inventory and current market conditions, We expect to have another good year in 2024. We will provide additional information during our Q4 call.

Speaker 1

Moving to slide 7. We continue to advance our sustainability journey. We're helping our customers achieve their climate related objectives by continuing to invest in new products, For example, Caterpillar provides a number of low carbon intensity solutions to customers. In Construction Industries, the Cat 980XE Wheel Loader, which features a Cat designed and manufactured continuous variable transmission, improves fuel efficiency by as much as 35% And reduces CO2 emissions by as much as 17% compared to the previous model. We also introduced The new CAT G3600 Gen 2 engine, the latest evolution of the powerful G3600 series offering lower emissions.

Speaker 1

With more than 8,500 CAT G 3,600 units in the field, the Gen 2 engine is designed to build upon the platform's robust performance to provide a 10% increase in power and lower emissions compared to the previous model. We've also made several joint announcements with customers that demonstrate our commitment to support their climate related objectives. I'll highlight one here. In September, Caterpillar and Albemarle introduced a unique collaboration Aim to support their efforts to establish Kings Mountain, North Carolina as the first ever zero emissions lithium mine in North America, while also making lithium available for use in caterpillar battery production. These examples reinforce our ongoing sustainability leadership With that, I'll turn it over to Andrew.

Speaker 2

Thank you, Jim, and good morning, everyone. I'll begin with commentary on the Q3 results, including the performance of our segments. Then I'll discuss the balance sheet and cash flow before concluding with our assumptions for the Q4 and full year. Beginning on Slide 8, our overall operating performance was strong. Adjusted operating profit margin, adjusted profit per share and ME and T free cash flow all were better than we expected, Our sales grew in line with our expectations.

Speaker 2

Based on the strong Q3 and year to date operating performance, We now expect that the adjusted operating profit margin for the year will be slightly above the top end of our target range at the corresponding level of sales. We also anticipate that MENT free cash flow will exceed the target range of $4,000,000,000 to $8,000,000,000 In summary, sales and revenues increased by 12 percent or $1,800,000,000 to $16,800,000,000 The sales increase versus the prior year was driven primarily by price realization as well as higher sales volume. Operating profit increased by 42 percent or $1,000,000,000 to $3,400,000,000 The adjusted operating profit margin was 20.8%, An increase of 4.30 basis points versus the prior year. Profit per share was $5.45 in the Q3 of this year. This included restructuring costs of $0.07 per share as compared to $0.08 in the prior year.

Speaker 2

We continue to expect restructuring expenses About $700,000,000 for the full year. Adjusted profit per share increased by 40% to $5.52 in the 3rd quarter compared to $3.95 last year. Other income of $195,000,000 was lower than that Then the Q3 of 2022 by $47,000,000 The decline was driven by less favorable currency impact in the quarter Related to N E and T balance sheet translation as compared to the prior year, along with the recurring increase in pension expense Of approximately $80,000,000 per quarter. Higher investment and interest income acted as a partial offset. The provision for income taxes in the 3rd quarter excluding discrete items reflected a global annual effective tax rate of 22.5%, which is the rate we now expect for the full year.

Speaker 2

The slightly lower than expected tax rate along with discrete items added about $0.14 to profit Moving on to Slide 9. As I mentioned, the 12% increase in the top line versus The prior year was primarily due to price realization as well as higher sales volume. Volume improved as sales to users increased by 13%, However, by segment, construction industry sales were higher, resort industries were in line, And Energy and Transportation sales were lower than we had anticipated. Services revenues increased in the 3rd quarter. We will update you with our progress towards our services growth target when we report our Q4 results and as is our normal practice.

Speaker 2

Price realization was slightly better than we had expected for the quarter. However, as we anticipated, we did see the magnitude of the year over year price effect Moderate compared to the Q2 as we lapped prior year price increases. Volume was slightly below our expectations. As Jim mentioned, sales to users were lower than we had anticipated, principally in Energy and Transportation. However, this was nearly offset by the increase in dealer inventory versus our expectations of it being about flat for the quarter.

Speaker 2

The deal increase in dealer inventory was driven primarily by Construction Industries. There we had stronger than expected shipments in North America, The typical dealer inventory range of 3 to 4 months of sales. We also saw some dealer inventory increase in Energy I'll remind you that dealer in between Energy and Transportation and Resource Industries is mainly a function of the commissioning pipeline With over 70% of dealer inventory in these segments backed by firm customer orders. Because dealer inventory is more a function of commissioning in Resource Industries and Energy and Transportation. It is difficult for us to predict in these two segments.

Speaker 2

I will discuss further our full year expectations for dealer inventories a little bit later. Moving to Slide 10. 3rd quarter operating profit increased by 42 percent to $3,400,000,000 while adjusted operating profit increased by 41% to $3,500,000,000 Price realization, which included a slight benefit from a shift in the geographic mix of sales and sales volume were favorable in the quarter. Our largest headwinds to operating profit were higher SG and A and R and D expenses and higher manufacturing costs. SG and A and R and D expenses included higher strategic investment spend.

Speaker 2

Manufacturing cost increases included higher material costs And unfavorable cost absorption as we reduced our inventories compared to a corresponding increase in the Q3 of 2022. Lower freight costs acted as a partial offset within manufacturing costs. The adjusted operating profit margin of 20.8% improved by 4.30 basis points. This was better than we had anticipated, primarily due to favorable manufacturing costs, Of which freight was the largest contributor. Also the slightly better than expected price helped margins.

Speaker 2

Now I'll discuss the performance of the segments. On Slide 11, Construction Industry sales increased by 12% in the 3rd quarter to $7,000,000,000 primarily due to favorable price realization. By region, sales in North America rose by 31% due to higher sales volume and favorable price. As I mentioned, supply chain improvements enable stronger than expected shipments in North America, which supported some dealer restocking. Sales of equipment to end users were in line with our expectations for the region.

Speaker 2

Sales in Latin America decreased by 31%, mainly due to favorable price and currency impacts. Sales in Asia Pacific decreased by 8%, primarily due to lower sales volume driven by lower sales of equipment to end users. 3rd quarter profit for Construction Industries increased by 53% versus the prior year to $1,800,000,000 The increase was mainly due to favorable price realization. The segment's operating margin of 26.4 percent was an increase of 7 10 basis points versus last year. Margin exceeded our expectations on better volume, price and lower than anticipated manufacturing costs, primarily freight.

Speaker 2

Turning to Slide 12. Resource Industry sales grew by 9% in the 3rd quarter to $3,400,000,000 The increase was primarily due to favorable price realization, partially offset by lower sales volume. Volume decreases, higher sales of equipment to end users were more than offset by lower aftermarket subparts volume, which reflected changes in dealer buying patterns. 3rd quarter profit for Resource Industries increased by 44% versus the prior year to $730,000,000 Many due to favorable price realization. Profit was partially offset by the impact of lower sales volume, which included unfavorable product mix.

Speaker 2

The segment's operating margin of 21.8% It's an increase of 5.40 basis points versus last year. Margin was better than we had expected primarily due to lower than anticipated manufacturing costs driven by freight and price. Now on Slide 13. Energy and transportation sales increased by 11% in the 3rd quarter to $6,900,000,000 Sales were up across all applications. Oil and Gas sales increased by 26%, Power Generation sales were higher by 21%, Industrial sales rose by 5% And transportation sales increased by 6%.

Speaker 2

3rd quarter profit for energy and transportation increased by 26% versus the prior year to $1,200,000,000 The increase was mainly due to favorable price realization and higher sales volume, Partially offset by higher SG and A and R and D expenses, unfavorable manufacturing costs and currency impacts. SG and A and R and D expenses reflected ramping investments related to strategic growth initiatives. A reminder that most of our strategic investments relating to electrification and alternative fuels occur in this segment, which impacts reported margins. The segment's operating margin of 17.2% was an increase of 210 basis points versus the prior year. Margin was lower than we had anticipated, primarily due to lower than expected sales volume impacted by supply chain challenges for large engines And delivery delays for solar turbines.

Speaker 2

Moving to Slide 14, Financial Products revenue increased by 20 percent to $979,000,000 primarily due to higher average financing rates across all regions. Segment profit decreased by 8% to $203,000,000 The decrease was mainly due to a higher provision for credit losses at CAAT Financial. The unfavorable impact reflects a challenging comparison as we had reserve releases in the prior year as compared to a more typical provision expense in the Q3 of 2023. Of note though, through the Q3 of this year, provision expense for a comparable 9 month period Is at the lowest level for over 20 years. Business activity remains strong with our and our portfolio continues to perform well With past dues and write offs at historic low levels, past dues in the quarter were 1.96%, A 4 basis point improvement compared to the Q3 of 2022 and a decrease of 19 basis points compared to the 2nd quarter.

Speaker 2

Retail new business volume increased versus the prior year and though it declined compared to the Q2, this follows the typical seasonal pattern. In addition, we continue to see strong demand for used equipment and used inventory remains at low levels. Now on Slide 15. Our M and T free cash flow has been robust this year with another $2,900,000,000 generated during the 3rd quarter, With $6,800,000,000 generated through the 1st 3 quarters of this year, we expect to exceed our target of $4,000,000,000 to $8,000,000,000 this year. From a working capital perspective, we had a small inventory decrease of around $200,000,000 in the quarter.

Speaker 2

Looking ahead, CapEx in the Q3 was around $400,000,000 With about $1,100,000,000 in CapEx through the 1st three quarters, We continue to expect around $1,500,000,000 for the full year. Our balance sheet remains strong. We have ample liquidity with an enterprise cash balance of $6,500,000,000 and we hold an additional $4,300,000,000 Now on Slide 16, I will share some high level assumptions for the Q4 and the full year. During the Q4, we anticipate slightly higher sales as compared to the prior year. Price should remain favorable.

Speaker 2

We expect sales to users to continue to support good underlying growth, though changes in dealer inventories should act as an offset. As a reminder, we saw dealers increase inventories by $700,000,000 in the Q4 of 2022, Whilst we expect a decrease in the Q4 of this year, specifically in Construction Industries, we do not expect the seasonal sales increase typically Seen from the 3rd to the 4th quarter, those sales to users are expected to increase on both a sequential and year over year basis. Instead, we anticipate lower shipment volumes as we complete the CAT engine changeover in Building Construction Products And dealers reduce their inventories principally of excavators. This compares to a dealer inventory increase in the Q4 of 2022. Though we now expect that deal inventory in construction industries will be higher at the end of 2023 than it was at the year end 2022, We still expect it to be within the typical 3 to 4 months of sales range.

Speaker 2

A reminder, this is an average across All dealers and all products in construction industries and is difficult to predict with precision given over 150 independent dealers And hundreds of different products. Similar to last quarter, there are still areas and or products where dealers would like to have more inventory. As Jim has mentioned, we are very comfortable with the level of inventory held by dealers overall. In Resource Industries, we anticipate slightly lower sales as compared to the Q3 as a result of improvements in availability. We also expect lower sales versus the prior year, driven by changes in dealer inventory.

Speaker 2

In the Q4 of 2022, there was an increase in dealer for Resource Industries, while we expect to decrease in the Q4 of this year. We expect sales in Energy and Transportation to increase in the 4th As compared to the Q3 with higher solar turbines and rail deliveries. However, keep in mind that we continue to work through supply chain challenges, primarily impacting large engines. We also anticipate some moderation in industrial sales during the Q4 compared to recent high levels. Now I'll comment on our expectations for margins.

Speaker 2

We provided our adjusted operating profit margin target target chart to assist you in your modeling process. Based on our current planning assumptions, we anticipate the adjusted operating profit margin to be slightly above the target range for the full year 2023. This is based on the corresponding estimated level of sales. Your expectation for total enterprise sales this year will inform where margins could finish for the year. Specific to the Q4, we anticipate the adjusted operating profit margin to be lower than the 3rd quarter.

Speaker 2

We anticipate lower than normal volume leverage, particularly impacting Construction Industries for the reasons I mentioned previously. We also anticipate a negative segment mix impact to impact operating margins As construction industry sales would be a lower proportion of total sales as compared to the 3rd quarter. Price realization should remain positive, though we expect the magnitude of the favorability versus the prior year to moderate as we continue to lap more favorable pricing trends from last year. Therefore, the increases in margins that have occurred from price outpacing manufacturing Cost inflation should moderate in the Q4. In addition, as you look down the income statement for the prior year, there are a couple of points to note.

Speaker 2

First, short term incentive expense in the Q4 of 2022 was lower than normal due to the true up for the final outcomes This will be a headwind for year over year operating margins. However, this will be partially offset by favorability in other operating income Expense as we do not expect the significant currency translation losses that we saw in the Q4 of last year to recur. By segment in Construction Industries, we expect slightly lower margin compared to the 3rd quarter, assuming lower volume. We also anticipate lower sequential margins in Resource Industries as is typical impacted by cost absorption along with higher spend relating to Strategic Investments. In Energy and Transportation, we expect margins will be similar to the 3rd quarter with stronger volume offset by manufacturing costs And an unfavorable mix of products, which includes international locomotive deliveries in rail.

Speaker 2

Now turning to Slide 17, let me summarize. Adjusted profit per share is $15.98 through the 1st 3 quarters of the year, which already exceeds our previous full year record by 15%. We generated strong adjusted operating Profit margin was a 430 basis point increase to 20.8%. We now expect MENT free cash flow remained robust with $6,800,000,000 year to date. We now expect MENT free cash flow to exceed our $4,000,000,000 to $8,000,000,000 target range for the full year.

Speaker 2

We continue to execute our strategy for long term profitable growth. And with that, we'll take your questions.

Operator

Thank you. Please note, we are only allowing one question per analyst. And your first question comes from Michael Feniger with Bank of America. Your line is open.

Speaker 3

Yes. Thank you for taking my question. Just based on where the backlog sits today, you discussed the easing supply condition Impacting lead times, orders, as that normalizes, do you expect the backlog to consolidate at these levels and then move higher? You mentioned some capital discipline with customers. Just curious, Jim, with where commodity prices are for oil, iron or copper, is that enough to support growth in 2024?

Speaker 3

Thank you.

Speaker 1

Yes. As I mentioned, we do expect another good year in 2024 and we'll provide more detail in January. We talked about this a bit in our last quarterly call. Our Backlog is higher than it normally would be because our lead times are higher than I'd like them to be frankly. And what we've talked about is as supply Conditions continue to improve.

Speaker 1

We expect lead times to come down, which should have a corresponding Impact on our backlog, our backlog should come down. So that's a positive thing. If you look at our backlog over a number of years, it's Still elevated compared to where it normally would be based on revenue. So again, we do feel good about market conditions And we expect that as we improve lead times that backlog as a percentage of revenue would come down to more normal levels.

Speaker 2

Yes, let me just give you some numbers to add to that. I mean, if you look at the backlog as a percentage of trailing 12 month revenues in the period of 2017, it was 37%. In 2018, it was 32%. Currently today, it's around 44%. So backlog still is elevated based on historic trends and remind you also that services revenues now are a higher proportion of our total revenue base As well.

Operator

And we will take our next question from Tami Zakaria with JPMorgan. Your line is open.

Speaker 4

Hi, good morning. Thank you so much. Staying on backlog, I think orders were down in the Q3. Have you seen any improvement in order trends quarter to date? Or if orders continue to be down, what would support a good year in 2024 like you mentioned in your call?

Speaker 1

It's based on again improving availability, so that wasn't a surprise to us. Again, what would give us another good year in 2024 It's market conditions. I mean, again, if we look at where we are in most of the markets we serve, we feel quite good. Starting with just with Construction Industries in North America, the infrastructure investments that are being made by the government, although we are starting we have seen some benefit of that, we expect more benefit In 2024, residential, although the growth rate has continued to moderate in North America, it is still growing. In oil and gas still remains quite healthy for solar turbines.

Speaker 1

Gas compression in oil and gas is strong as well. So again, there's a lot of positive things. Power generation, data center growth continues to provide A tailwind as well. So again, there's a lot in the market conditions would lead us to believe that we'll have another good year next year. And Tammy, just

Speaker 2

to add again a little bit more, remind you that specifically in the Q3, there were two factors which did impact order rates. One which is obviously as we talked about the CAT engine changeover for a number of quarters that happening in the Q4. If you think about when dealers replace orders BCP machines, they would tend to impact us in the Q3, which is why we saw those order rates decline. Similarly, we also saw some excavator orders client in anticipation of dealers reducing their inventory levels as well. So overall, those are specific factors in the Q3 themselves, Which actually moderated the overall order rates as well.

Speaker 1

Maybe just another comment about that BCP changeover. We deliberately limit the number of orders Because we have a fixed amount of machines being built prior to that changeover to the new model. And then we close the order board at some point when we run out of allocation And we haven't yet opened the order board for the new model. So again, that helps explain the reduction in order rates for BCP Around that engine changeover. And again, as expected, we also have talked about the fact that we expect dealers to bring down excavator inventory.

Speaker 1

And again, that would reflect that would result in a lower order rate as well for CI for excavators. So again, none of this is surprising.

Operator

And we will take our next question from Rob Wertheimer with Melius Research. Your line is open.

Speaker 5

Yes. Hi. My question is on resources and it's going to be basically on business model, revenue model And margin. And so you announced the deal with Freeport today on retrofit of autonomous mining trucks. And I know you've had retrofit for a while.

Speaker 5

I don't recall An announcement quite this big, although maybe I missed 1 or 2. But the question is really as you see deals like that, You deliver value to customers through autonomous operations, saving direct and indirect costs. How do you think about margin support for you guys? And then how do you think about market share going forward? I think a year ago you'd sort of won a large majority of autonomous mining contracts or tenders out there.

Speaker 5

And I'm wondering if you can give us an update on that, so kind of Market Share, Margin and Business Development. Thank you.

Speaker 1

You bet. And Rob, we have talked in the past about the fact that we are very Bullish about our autonomous solution. We do believe we have the best solution in the industry because our trucks move faster and we're able to allow our customers to produce More commodity in a 24 hour period. We continue to invest in our autonomous capabilities and continue To add more value and that's really resulting in us receiving orders like the ones that the one that was announced this morning. Certainly, we're always striving to add more value that helps again.

Speaker 1

It's not just about cost competition, it's providing more value to customers to make them more successful. We have talked about the fact that our customers in mining are displaying capital discipline. That's not surprising. Quotation activity is quite high And number of parked trucks is low. So again, if one thinks about the energy transition, combines that with our autonomous solution, we do feel good about Resource Industry is currently in mining moving forward.

Operator

And we will take our next

Speaker 6

We work within for providing margin guidance, but I must say the Q4, I mean, it's implying a range of EPS that you Drive a truck through. So I'm just trying to get a little better sense of, I think I heard you say the margins in CI and RI Slightly below the Q3 and ENT similar. But then when you get to that Yes, that range of whatever you think your sales are, I mean, we have a rough idea of what you're thinking for sales given the Q4 guide. I'm just trying to get a sense of the margins year over year at least appear that they'll be up. Is that a fair statement?

Speaker 6

But the slight on RI and CI almost make it seem like it's down only 100 bps or 150 sequentially. So I apologize for the granularity, but It's just a wide range. I just want to make sure we understand. Thank you.

Speaker 2

Yes, David, thank you. So, obviously, was Slightly different. So if you got to think about it from a sequential basis and also year over year. So we try to give a little bit of color on both. On a sequential basis, we do expect obviously both CI and RI margins If you think normally there's a seasonality for both of those, what exacerbates that probably above the normal level of seasonality, particularly in CI, Is the expectations for volume to impact be impacted by dealer inventory, so that will have a slightly bigger impact than normal on CI.

Speaker 2

On E and T, as I said, we expect them to be broadly flat compared to the Q3. Some of that is due to product mix and timing of international rail deliveries, which are low margin business. Then on top of that, so that's Sequential quarter over quarter driving that. And then if you look year over year, obviously, yes, we do expect both CI and RI and ENT margin improvement year over year. What will slightly offset that will be some increase in corporate items As a result of the true up of incentive comp that I talked about a moment ago, On a PPS basis, offsetting that will be some favorability in other income and expense because last year, if you remember, We did have a big one time charge for currency translation losses, which impacted the 4th quarter.

Speaker 2

So hopefully that gives you a little bit more color Overall, but that's sort of trying to get the way we can guide you from a margin perspective. Hopefully, that's helpful.

Operator

And we will take our next question from Steven Fisher with UBS. Your line is open. Thanks.

Speaker 7

Good morning. So clearly terrific margins this year. Pricing is such a strong driver at the moment, but Year over year, as you said, is moderating a bit. I'm just curious about your strategy on how to manage in the lower pricing growth environment going forward. I mean to what extent do you think you can ramp up the cost focus there?

Speaker 7

And if that's a key part of the plan, Kind of what are the biggest opportunities for cost savings next year? Or do you think the sort of a narrower price versus cost is really just the base case from here?

Speaker 1

Well, thank you, Stephen. And as we mentioned, we do expect pricing to moderate just based on lapping the price increase As we had last year, we're continually focused on having a lower cost structure. We're looking for ways to reduce structural cost. A lot of things there back office now being performed in lower cost countries, more engineering done in lower cost countries, Looking at ways to become more efficient. I also mentioned the fact that we supply chain has improved, but we still have some challenges and some surprises there that Create some incremental cost due to inefficiencies based on having shortages.

Speaker 1

So I do believe there is still an opportunity for us moving forward to

Operator

And we will take our next question from Tim Thean with Citigroup. Your line is open.

Speaker 3

Hi. Good morning. Thanks for the time. Yes, maybe just continuing on that thread there in terms of Pricing and just thinking about kind of the outlook into 2024, I'm interested from a competitive dynamic. If you look historically, especially focused in CI and a market with a lot of global competitors and You're just looking at the dollar yen relationship where it is near decade high levels.

Speaker 3

Just maybe talk about What you're seeing, what your dealers are seeing from competitive dynamics and your thoughts into 2024, in terms and how that

Speaker 1

A lot of dynamics there. 1, of course, is the strength of the market. So if you think about the strength of the market in North America for the reasons we've Drive infrastructure spending and continued growth in residential, certainly we feel good about market conditions. Competition, we've always had competition, we always will. We make pricing decisions based on a whole variety of factors.

Speaker 1

Certainly, we look at input cost, we look at Our competitors, we looked at other factors in the market and we make decisions. There's no one big decision. We make A whole variety of decisions are based on what we're seeing in the market at any one time. We're always focused on remaining competitive, Pricing for value, no one likes to raise prices, but of course in the last couple of years we've been in an inflationary cost environment. But we're always looking to add more value to our customers, Adding technology things to make our customers more efficient.

Speaker 1

You stop and think about the labor shortage that we have now. Some of the technology that we're putting into our construction industries products allows less experienced operators to be more effective more quickly. And so all those kinds of things help add value to our customers and of course, we're investing in our digital capabilities and our services capabilities as well to help Reduce downtime, unplanned downtime, increased productivity. So that all goes into it. But certainly, we recognize it's a competitive world out there, always has been, always will be.

Speaker 1

But we feel confident about our ability to continue to compete effectively.

Operator

And we will take our Question from Nicole DeBlase with Deutsche Bank. Your line is open. Yes, thanks. Good morning, guys.

Speaker 2

Good morning, Nicole. Good morning, Nicole.

Operator

Just on the parts demand, noticed that you guys caught out decline in aftermarket parts and resource as a If you could talk a little bit about that and then any color on parts demand in construction or E and T. Thank you.

Speaker 2

Yes. Nicole, thank you. Within Resource Industries, the volume did decline. It doesn't necessarily mean the Dollar value declined, but the volume decline was partly due to dealer buying patterns. And so that was a factor within resources.

Speaker 2

Overall, we're still very comfortable with the growth rate of aftermarket parts volumes and we'll give you the update as per normal, as I said in my remarks, in January. But overall, services revenues still continue to grow and are a very good Factor for us, as you know, given our drive to double services revenue to $28,000,000,000 by 2026.

Speaker 1

And dealer sales to customers were up in the quarter. Yes.

Operator

And we will take our next question Chad Dillard with Bernstein. Your line is open.

Speaker 8

Hi, good morning guys. Hi, Chad. I have more of a bigger picture question.

Speaker 2

So I was hoping you could

Speaker 8

give us an update on your approach to rental. So to what extent are you looking to expand your footprint through dealers in this channel? And if you can share, how much of your sales today come through this channel today? And then if we do see any near term air pocket, Do you think any fleet expansion could provide an offset?

Speaker 1

Yes. We do see rental as a growth opportunity and we're working with our dealers to improve our rental business. We set up A new division, in the last year or so with a senior experienced Senior Vice President leading that division to help Increased rental. The rental industry is in fact growing. And so we've been refreshing our rental growth strategy and working with our dealers to allow them More sustainably grow revenue in rental.

Speaker 1

So again, it's we do think it's an opportunity. It's a good one for us to be focused on.

Operator

And we will take our next question from Kristen Owen with Oppenheimer. Your line is open. Great. Good morning. Thank you for the question.

Operator

Good morning. I was wondering if you could provide a little bit more commentary on the manufacturing cost increase in the quarter, How to think about that going forward? I mean, this is the easiest comparison of the year and in a more favorable cost environment. So just Trying to think about how much of the manufacturing cost increases may be related to timing of orders versus we're still seeing some inflation in the supply chain.

Speaker 2

Yes. We are still seeing it's a bit of mix across the businesses. Material costs are still growing in some areas and other areas growing less Rapidly, so that's sort of the bigger part of that from an overall manufacturing cost perspective. Other factors include things like, particularly for us this quarter, things like absorption impacted us, But overall, we are seeing lower levels of manufacturing cost inflation We have done historically, and partly offset by some benefits in freight, which are helping us. Really does depend by segment by segment.

Speaker 2

So one of the things just to remind everybody, we are not a uniform business as far as We only serve 1 market. We serve a variety of different markets. Markets are in different parts of their growth phase as a result of Post the COVID impact, that means that therefore that some of those cost increases are coming through in a different way Business to business, as well as then our ability to price to offset some of that as well.

Operator

And we will take our next question from Mig Dobre with Baird. Your line is open.

Speaker 9

Yes. I wanted to ask a question surrounding dealer inventories. They bill $2,600,000,000 year to date, Which seems to be a little bit different than the way you were framing expectations. So I guess I'm curious, first, how do you expect These are inventories still exiting 2023. Why is there a bit of a variance relative to your initial expectations?

Speaker 9

And Lastly, if we are indeed going into a bit of a dealer destock mode, does it stand to infer that your incoming orders Are going to continue to be soft and obviously backlog continues to erode. Thank you.

Speaker 2

Yes. So, Nick, a couple of comments. One which we tried to explain in the last quarter. We dealer inventory, we give you one number for 150 independent dealers With a very large number of products underneath that and underpinning it. So it is very complex.

Speaker 2

Secondly, CI is a Slightly different model from RI and ENT. ENT and RI represent about 40% of the increase in dealer inventory. That's really a function of commissioning. Over 70% of those orders are for firm customer orders. They're not sitting on a lot Waiting for somebody to come in and buy them.

Speaker 2

There, effectively, it's less it's more difficult to predict because it depends on the commissioning time, And obviously, it's also more difficult to predict because of the nature of the business and how they are moved through, For example, a large mining truck which is disassembled and then reassembled on-site and the revenue recognition coming from the dealer as part of that. So it's a very different part of the business. That's why effectively, we almost can't predict that with much certainty. It is much more difficult to predict. With regards to CI, we've always said probably normal range is between 3 4 months of inventory.

Speaker 2

At the moment, we're within that range. Dealers will have within excavator inventory. They're slightly at the top end of that range. They want to bring them down. We agree with that.

Speaker 2

We think that's a good thing. That will reduce, obviously inventories as we move in. Within, as we said, with BCP and also with earthmoving, particularly in North America, which are the largest markets for those products, We are at the low end of the range and givers could actually want to hold a little bit more. So overall, net net, we do expect a decline in the 4th quarter. It's going to have an impact possibly will there be some impact in the Q1 next year?

Speaker 2

Probably not. Just to remind you, we normally see a dealer inventory build in the first of the getting ahead of ready for summer selling season, so it may not be quite as big as normal. But overall, there are some seasonality parts of our business. With regards to the backlog, backlog is completely different. Remember, for CI, backlog is a function of dealer orders.

Speaker 2

For ENT, it's a function of And our eye is much more of a function of firm customer orders underpinning those within so as we think about dealers, So one of the things we've done, as you know, through our S and OP process is trying to moderate over orders, and we think we're doing a better job of trying to avoid Some of the swings which caused production swings as a result of dealer inventory buying patterns. Overall, just to remind you, finally, We still expect sales to users to grow in the Q4 of this year. We're still expecting our end demand to remain strong And that sets us up into 2024 as we move forward.

Operator

And we will take our next question from Mike Slusky with D. A. Davidson, your line is open.

Speaker 10

Yes. Hi. Good morning. I wanted to ask about interest rates real quick. Thank you.

Speaker 10

Yes, hello. On interest rates, you kind of touched on it, but maybe a little more color. How have high interest rates or higher interest rates affected the dealership inventory desire and their ability to actually pull and carry inventory? And secondly, maybe have house interest rates, have they affected any end use appetite to buy

Speaker 2

Yes. So, first of all, let me say on higher interest rates, Probably today, just to remind you that even though there are many of us who remember 5% as being the normal interest rates, I know we've lived that through lower for the last decade. Overall though, it's really a function dealers hold inventory based on what their expectations of future demand are. We are comfortable holding current levels of inventory. And as I said, we'd like to hold more for particularly BCP and earthmoving products and hold a little bit less of excavators.

Speaker 2

But that's a reflection of their expectations of sales to users rather than actually of interest rates. I think they're a little bit less sensitive to that, assuming that they can actually sell the equipment on. As far as actually our customers are concerned, Where it does impact us within Caterpillar is in Cat Financial. We have seen a slight reduction in Share of new machines we are financing within CAF Financial because we fund in the wholesale market. So we're slightly less competitive against banks.

Speaker 2

But generally, customers have either been paying cash. They have the work, so they haven't been sensitive to interest rates in as far as buying machine And overall, if you look, and this is one thing we keep a very close focus on, write offs, past dues And the like and provision spend levels, we are our customers are in very robust shape And do not appear to be being impacted by the higher interest rates yet. So nothing we've seen yet tend to indicate that there's any Impact of that today on that business.

Operator

We will take our next question from Jerry Revich with Goldman Sachs. Your line is open.

Speaker 11

Yes. Hi. Good morning, everyone.

Speaker 2

Hi, Jerry.

Speaker 11

Hi. Jim, I'm wondering if you could just talk about where lead times stand in mining equipment. I know it's a broad range of products, but can you get us a sense for how far Visibility you have and if you're willing to quantify the comments you made earlier about really good pipeline just within the context of Relative to the really strong bookings rate we've had year to date, any way to quantify the pipeline versus

Speaker 1

Yes. So we have been working hard to bring lead times down as I mentioned. We do feel good about where we are in that process. And so we had over the last couple of years some real challenges around Availability, but it has gotten better in most areas. Probably the area that's still a challenge is large engines.

Speaker 1

But in mining, we do feel good about where we are in terms of the progress we've made around lead times. Yes.

Speaker 2

And as far as the quoting activity, there is a lot of activity, Jerry, going on. As we've said, one of the Slightly we would have anticipated more of that coming into order rates. There seems to be some slight delay in actually pushing the button On committing to firm orders, as we have seen.

Speaker 1

Abby, we have time for one more question.

Operator

Thank you. Today's final question will come from the line of Steve Volkmann with Jefferies. Your line is open.

Speaker 12

Great. Good morning, everybody. Thanks for fitting me in. I just wanted to go back to rental, if I could. And I'm curious, Jim, would you characterize the Cat dealer rental fleets in terms of size?

Speaker 12

Do they want more equipment? And can you also just

Speaker 1

Yes. One of the things that's been happening over the last year or so is that there has been some Upgrading of that fleet because it had gotten quite old because of some of the supply challenges we've had. And so, I'm reluctant Characterize the size of that in total, but again, we are working with our dealers to help them grow rental. We want them to have A successful profitable rental business and that means having the right size of rental inventory for the amount of business that they So again, it has been a bit aged. It's improved a bit, but there's still some room there To have newer machines going into the fleet because it had again gotten quite aged.

Speaker 1

And again, our expectation here is as we grow rental That the fleet should grow. But again, we want the goal is not to have higher bigger size rental fleets. The goal is to have Profitable growing rental businesses by our dealers, which they want to be as efficient as they can with turns. And but over time, that should result in larger rental All right. Well, thank you.

Speaker 1

That was our last question. Thanks all for joining us and we always appreciate your questions. I'd like to just close by thanking our team for another great quarter. As I mentioned earlier, due to our strong results in the Q3, we Free cash flow and that reflects continuing healthy customer demand and our strong operating performance. And we're continuing to execute our strategy and Investor Long Term Profitable Growth and we look forward to updating you again in January.

Speaker 1

Great. Thanks Jim, Andrew and everyone who joined us today. A replay of our call will be available online later this morning. We'll also post a transcript on our Investor Relations website as soon as it's available. You'll also find a Q3 results video with our CFO and an SEC filing with our sales to users data.

Speaker 1

Click on investors. Caterpillar.com, then click on financials If you have any questions, please reach out to Rob or me. The general phone number is 309-675-4549. Now, we'll turn it over to Abby to conclude the call.

Operator

Thank you. Ladies and gentlemen, this concludes today's call and we thank you for your participation. You may all disconnect.

Earnings Conference Call
Caterpillar Q3 2023
00:00 / 00:00