Caterpillar Q2 2023 Earnings Call Transcript

Quartr
Provided by Quartr
August 1, 2023

There are 14 speakers on the call.

Operator

Ladies and gentlemen, welcome to the Second 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, Brian Fiedler. Thank you. Please go ahead, sir.

Speaker 1

Thanks, Abby, and good morning, everyone, and welcome to Caterpillar's Q2 of 2023 earnings call. I'm Ryan Fiedler, Vice President of Investor Relations. Joining me today are Jim Upledeed, 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 2nd quarter earnings release we issued earlier today. You can find our slides, the news release And a webcast recap at investors.

Speaker 1

Caterpillar.com under Events and Presentations. The content of this call is protected by U. S. And international copyright law. Any rebroadcast, retransmission, reproduction or distribution of all or part of this content without Caterpillar's prior written permission is prohibited.

Speaker 1

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, a detailed discussion of the many factors that we believe may have a material effect Our business on an ongoing basis is contained in our SEC filings. On today's call, we'll also refer to non GAAP numbers.

Speaker 1

For a reconciliation of any non GAAP numbers to the appropriate U. S. GAAP numbers, please see the appendix of the earnings call slides. Now let's turn to Slide 3 and turn the call over to our Chairman and CEO, Jim Umpleby.

Speaker 2

Thanks, Ryan. Good morning, everyone. Thank you for joining us. As we close out the first half of twenty twenty three, I want to recognize our global team for delivering a very strong second quarter. This included double digit top line growth, higher adjusted operating profit margin, record adjusted profit per share and robust ME and T free cash flow.

Speaker 2

Our results continue to reflect healthy demand across most end markets for our products and services. We remain focused on executing our strategy And continue to invest for long term profitable growth. In today's call, I'll begin with my perspectives on our performance in the quarter. I'll then provide some insights on our end markets. Lastly, I'll provide an update on our sustainability journey.

Speaker 2

It was another strong quarter. Sales and revenues increased 22% in the Q2 versus last year. Adjusted operating profit margin improved 21.3%, up sequentially and year over year. We also generated $2,600,000,000 of ME and T free cash flow in the quarter. Our Q2 results were better than we expected for sales and revenues, adjusted operating profit margin and ME and T free cash flow.

Speaker 2

In addition, we ended the quarter with a healthy backlog of $30,700,000,000 We continue to see improvement in the supply chain, which allowed us to increase production in the quarter. However, areas of challenge remain, particularly for large engines, which impacts energy and transportation And some of our larger machines. While we continue to closely monitor global macroeconomic conditions, we now expect our 2023 results to be better than we had previously anticipated. Turning to Slide 4, in the Q2 of 2023, sales and revenues increased by 22% $17,300,000,000 This is primarily due to higher sales volume and price realization. Sales volumes were higher than we expected, Largely due to an increase in dealer inventory relating to energy and transportation, which is supported by customer orders.

Speaker 2

We saw double digit increases in sales and revenues in each of our 3 primary segments. Compared with the Q2 of 2022, Overall sales to users increased 16%. For machines, which includes Construction Industries and Resource Industries, sales to users rose by 8%. Energy and Transportation was up 47%. Sales to users in Construction Industries were up 3%.

Speaker 2

North American sales to users increased and were better than expected as demand remained healthy for nonresidential and residential construction. Nonresidential continue to benefit from government related infrastructure and construction projects. Residential sales to users in North America also increased in the quarter. EAME saw lower sales to users due to weaker than expected market conditions in Europe. The Middle East continued to demonstrate strong construction activity.

Speaker 2

In Latin America and Asia Pacific, sales to users declined in the quarter. In Resource Industries, sales to users increased 26%. In mining, sales to users increased, supported by commodities remaining above investment thresholds. Within heavy construction, in quarry and aggregates, Sales to users also increased, supported by growth for infrastructure related projects. In Energy and Transportation, Sales to users increased by 47% in the Q2.

Speaker 2

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 strength in sales of reciprocating engines Into oil and gas applications such as Tier 4 dynamic gas blending, gas compression and repowering active well servicing fleets. Power generation sales to users continued to remain positive due to favorable market conditions, including strong data center growth. Industrial and transportation sales to users also increased.

Speaker 2

Dealer inventories increased by $600,000,000 in the quarter, Lead by Energy and Transportation. We are very comfortable with the total level of dealer inventory, which remains in the typical range. Adjusted operating profit margin increased to 21.3% in the 2nd quarter as we saw improvements both on a sequential and year over year basis. Adjusted operating profit margin was better than we had anticipated, primarily due to better than expected volume growth and lower than expected manufacturing costs, including freight. Moving to Slide 5.

Speaker 2

We generated strong ME and T free cash flow of $2,600,000,000 in the 2nd quarter. We returned $2,000,000,000 to shareholders, which included about $1,400,000,000 in repurchase stock and $600,000,000 in dividends. In June, we announced an 8% dividend increase. Since May of 2019, when we introduced our current capital allocation strategy, We have increased the quarterly dividend per share by 51%. We remain proud of our dividend aristocrat status and continue to expect to return substantially all And we will be conducting a question and answer session.

Speaker 2

Now on Slide 6, I'll describe our expectations moving forward. While we continue to closely monitor global macroeconomic conditions, our 2nd quarter results lead us to expect That full year 2023 will now be even better than we described during our last earnings call. We now expect adjusted operating profit margins to be close to the top of the targeted range relative to the corresponding expected level of sales. This positive operating performance increases our expectations For ME and T free cash flow, which we now expect to be around the top of the $4,000,000,000 to $8,000,000,000 range for the full year. Our current expectations for adjusted operating profit margin and ME and T free cash flow reflect continuing healthy customer demand And our strong operating performance.

Speaker 2

Now I'll discuss our outlook for key end markets this year, starting with Construction Industries. In North America, overall, we continue to see positive momentum in 2023. We expect continued growth in non residential construction North America due to the positive impact of government related infrastructure investments and a healthy pipeline of construction projects. Although residential construction growth has moderated, we expect the rest of 2023 to remain healthy. In Asia Pacific, excluding China, we expect growth in construction industries due to public infrastructure spending and supportive commodity prices.

Speaker 2

We mentioned during our last earnings call that we expected sales in China to be below the typical 5% to 10% of our enterprise sales. We now expect further weakness as the 10 tons and above excavator industry has declined even more than we anticipated. In the EMEA, we anticipate that it will be flat to slightly up overall with the Middle East exhibiting strong construction demand, Whereas Europe is expected to be down. Construction activity in Latin America is expected to be down in 2023 versus Strong 2022 performance. In Resource Industries, we expect healthy mining demand to continue As commodity prices remain above investment thresholds.

Speaker 2

As I've mentioned previously, customers remain capital disciplined, which supports a gradual increase in mining over time. We anticipate production and utilization levels will remain elevated. We also expect the age of the fleet and the low level of park trucks to support future demand for our equipment and services. We continue to believe the energy transition will support increased commodity demand, expanding our total addressable market and providing further opportunities for profitable growth. In heavy construction and quarry and aggregates, we anticipate continued growth due to major infrastructure In non residential construction projects.

Speaker 2

Now, I'll discuss energy and transportation. For cat reciprocating engines in oil and gas applications, Although customers remain disciplined, we are encouraged by continuing strong demand for gas compression. Cat reciprocating engine demand for power generation is expected to remain healthy, including strong data center growth. New equipment orders and services for solar turbines in both oil and gas and power generation remain robust. Industrial continues to be healthy.

Speaker 2

In transportation, we anticipate strength in high speed marine as customers continue to upgrade aging fleets. Moving to Slide 7. We continue to advance our sustainability journey. Since our last quarterly earnings call, we published our 2022 sustainability report, which disclosed our estimated scope 3 greenhouse gas emissions for the first time. We also published our first ever task force on climate related financial disclosure We're helping our customers achieve their climate related goals by continuing to invest in new products, technologies and services And lower emissions after purchasing our Cat D6XE, the world's 1st high drive diesel electric drive dozer.

Speaker 2

The customer reported a 30% reduction in fuel consumption versus the previous model working in the same operation. This example reinforces our ongoing sustainability leadership and how we help our customers build a better, more sustainable world. With that, I'll turn the call over to Andrew.

Speaker 3

Thank you, Jim, and good morning, everyone. I'll begin with commentary on the Q2 results, including the performance of our business segments. Then I'll discuss the balance sheet and free cash flow before concluding with our assumptions for the remainder of the year, including color on the Q3. Beginning on Slide 8, our team delivered a very strong second quarter as overall results Exceeded our expectations on strong operating performance. We saw healthy top line growth, Improved operating margins and robust ME and T free cash flow.

Speaker 3

For the year, we now expect our adjusted operating profit margin to be close to the To be around the top of our $4,000,000,000 to $8,000,000,000 target range. To summarize the results, sales and revenues increased by 22 percent 3 $100,000,000 to $17,300,000,000 Sales increase versus the prior year was due to higher sales volume and price realization. Operating profit increased by 88 percent or $1,700,000,000 to $3,700,000,000 The adjusted operating profit margin was 21.3 percent, an increase of 7.50 basis points versus the prior year. Adjusted profit per share increased by 75 percent to $5.55 in the 2nd quarter compared to $3.18 last year. Profit per share was $5.67 in the Q2 of this year.

Speaker 3

This included discrete deferred tax benefit of $0.17 per share, while restructuring costs were $0.05 per share, flat compared to the prior year. We continue to expect restructuring expenses of about $700,000,000 for the full year. Other income of $127,000,000 in And a recurring increase in quarterly pension expense of approximately $80,000,000 which we initially spoke to you about in January. Higher investment and interest income acted as a partial offset. The provision for income tax in the 2nd quarter, excluding discrete items, reflected a global annual effective tax rate of approximately 23%, which remains our expectation for the full year.

Speaker 3

Moving on to Slide 9. The 22% increase in the top line versus the prior year was Due to higher sales volume and price, volume improved as sales to users increased by 16% and from changes in dealer inventory. Sales for the quarter were higher than we had anticipated mostly due to volume. The volume outperformance reflected a dealer inventory increase, Which is primarily due to our stronger than expected shipments in energy and transportation, particularly in power generation, which is in line with strong data center demand. Price realization was in line with our expectations for the quarter.

Speaker 3

As I mentioned, sales to users grew by 16% in the quarter. As Jim has discussed, demand remains healthy across most end markets for all our products and services and is supported by a healthy order backlog. Moving to Slide 10. 2nd quarter operating profit increased by 88%, while adjusted operating profit increased by 87% $3,700,000,000 Year over year favorable price realization and higher sales volume were partially offset by higher manufacturing costs, which largely reflected high material costs. An increase in SG and A and R and D expenses included higher strategic investment spend.

Speaker 3

The adjusted operating profit margin of 21.3% was better than we had anticipated. Volume exceeded our expectations, which supported the margin outperformance. In addition, manufacturing costs increased less than we expected due to lower freight costs And the lower than anticipated impact from cost absorption. SG and A and R and D expenses were about in line. Moving to Slide 11, I'll review the segment performance.

Speaker 3

Construction Industry sales increased by 19% in the second to $7,200,000,000 due to price realization and higher sales volume. By region, sales in North America rose by 32% Due to higher sales volume and price realization, stronger demand and supply chain improvements enabled stronger than expected shipments in North America. This supported stronger sales of equipment to end users and some dealer restocking in what remains our most constrained region. Sales in Latin America decreased by 11%, primarily due to lower sales volume, partially offset by price realization. In EME, sales increased by 20%, primarily the result of higher sales volume and price realization.

Speaker 3

Sales in Asia Pacific were about flat. 2nd quarter profit for Construction Industries increased by 82% versus the prior year to $1,800,000,000 The increase was mainly due to price realization and higher sales volume. This segment's operating margin of 25.2 percent was an increase of 8 80 basis points versus last year. Margin exceeded our expectations, largely due to better than expected volume of freight costs, which were lower than we had anticipated. Turning to Slide 12.

Speaker 3

Resource Industry sales grew by 20% in the 2nd quarter to $3,600,000,000 The increase was primarily due to price realization and higher sales volume. Volume increased due to higher sales of equipment to end users. Although aftermarket sales volumes were lower, dealer sales to customers for services remained positive. 2nd quarter profit for Resource Industries increased by 108% versus the prior year to $740,000,000 mainly due to price realization and higher sales volume. This was partially offset by unfavorable manufacturing costs, largely material costs.

Speaker 3

The segment's operating margin of 20.8 percent was an increase of 8.80 basis points versus last year. The segment's margin was better than we had expected, primarily due to favorable volume, timing of SG and A and R and D spend And lower than anticipated freight costs. Now on Slide 13. Energy and transportation sales increased by 27% 2nd quarter to $7,200,000,000 Sales were up double digits across all applications. Oil and Gas sales increased by 43%, power generation sales increased by 39%, Industrial sales rose by 18% and transportation sales increased by 12%.

Speaker 3

2nd quarter profit for energy and transportation increased by 93 versus the prior year to $1,300,000,000 The increase was mainly due to higher sales volume and price realization, partially offset by unfavorable manufacturing costs and higher SG and A and R and D expenses. The segment's operating margin of 17.6 percent was an increase of 600 basis points versus last year. The margin was generally in line with our expectations. Moving to Slide 14. Financial Products revenue increased by 16 percent to $923,000,000 primarily due to higher average financing rates across all regions.

Speaker 3

Segment profit increased by 11% to $240,000,000 The increase was mainly due to a lower provision for credit losses at CAAT Financial, partially offset by an increase in SG and A expense. Business activity remains strong and our portfolio continues to perform well. Past dues in the quarter were 2.15%, a 4 basis point improvement compared to the Q2 of 2022. This is the lowest Q2 past dues percentage since 2007. Retail new business volume performed well, Increasing versus the prior year and the Q1.

Speaker 3

In addition, we continue to see strong demand for used equipment. Now on Slide 15. Our EME and T free cash flow generation was again robust as we generated $2,600,000,000 in the quarter. This was an increase of $1,500,000,000 compared to the prior year. With approximately $4,000,000,000 generated in the first half, We now expect MENT free cash flow to be around the top of our $4,000,000,000 to $8,000,000,000 target range for the full year.

Speaker 3

CapEx in the Q2 was about $300,000,000 and we still expect to spend around $1,500,000,000 for the full year. As Jim mentioned, we returned about $2,000,000,000 through share repurchases and dividends in the Q2. Our balance sheet remains strong. We have ample liquidity with an enterprise cash balance of $7,400,000,000 And we also hold an additional $2,000,000,000 in slightly longer dated liquid marketable securities to improve yields on that cash. Now turning to Slide 16, I will share some high level assumptions for the second half and the third quarter.

Speaker 3

In the second half of twenty twenty three, we expect higher total sales and revenues as compared to the second half of last year. We anticipate both sales to users and price realization will be positive in the second half. Keep in mind that on a comparative basis, We start to lap the stronger price we saw from the Q3 onwards last year. Caterpillar sales will be impacted by changes in dealer inventories As dealers increase their inventories in the second half of last year, which is not typical, this is our expectation of a more typical reduction I want to spend just a few moments talking about dealer inventories. Dealers are independent businesses and they make their own decisions around the level of inventory they hold.

Speaker 3

We obviously work closely with them This impacts our production levels. As Jim mentioned, we are very comfortable with the levels of inventory that dealers are holding. We talk about dealer inventory in aggregate. This is difficult to predict with certainty as it arises from 3 different business segments, Over 150 dealers and hundreds of different products. In Resource Industries and Energy and Transportation, Dealer inventory is mainly a function of the commissioning pipeline.

Speaker 3

Keep in mind that over 70% of dealer inventory in these segments For construction industries, dealer inventory is principally a function of end user demand And availability from the factory. In Construction Industries, dealers typically increase inventories during the first half of the year. Around 60% of the $2,000,000,000 increase during the first half of this year was from products in this segment. The remaining 40% is in Resource Industries and Energy and Transportation. For Resource Industries and Energy Transportation, we Currently anticipate a slight reduction in levels in the second half, but this is dependent on commissioning.

Speaker 3

In Construction Industries, dealers are currently holding around the midpoint of the typical 3 to 4 month range. Some dealers would like to increase inventories of certain products such as BCP and earthmoving due to strong customer demand. Firstly, some dealers would like to reduce the levels of excavator inventory because of high availability. In addition, we are scheduled to replace 3rd party engines with CAT engines in certain products, which will impact production of these products during the second half. Our current planning assumption for Construction Industries is that dealers will reduce their overall levels of inventory in the second half of twenty twenty three with a principal focus on excavators.

Speaker 3

Overall, at the enterprise level, we currently expect dealer inventory should be slightly higher at the end of 2020 3 versus last year. Moving on. On the slide, we provide our adjusted operating profit Margins target chart to assist you in your modeling process. Based on our current planning assumptions, we anticipate full year adjusted operating margin to be close to the top of our 300 basis points target range at our expected sales level. Your expectation for total enterprise sales this year would inform you where on the curve margin should finish for the year.

Speaker 3

Specific to the second half, we anticipate adjusted operating profit margins in the remaining quarters of the year will be above the year ago levels, Although they will be lower than levels we saw in the 1st 2 quarters of this year. As compared to the first half, we anticipate a margin headwind from cost absorption in the second half. We do not expect to build our inventory as we did in the first half and anticipate that there will be some inventory reduction if we continue Price realization should remain positive, but the magnitude of the favorability versus the prior year is expected to be low in the second half as we lap the more favorable pricing trends from last year. Therefore, the increases in margins that we have occurred That have occurred from price outpacing manufacturing cost inflation should moderate in the second half of this year. Now let's move on to our assumptions that are specific to the Q3.

Speaker 3

We anticipate Q3 sales to be higher than the Q3 2022, But to exhibit the typical sequential decline when compared to the Q2 of 2023. In Construction Industries, as is our normal seasonal trend, we expect lower sales compared to the Q2. In Resource Industries, which can be lumpy, we anticipate slightly lower sales compared to the Q2. We expect sales in Energy and Transportation will increase slightly compared to the Q2. Specific to Q3 margins versus the prior year, adjusted operating profit margins at the enterprise level and segment Margins should be stronger.

Speaker 3

However, we do expect lower enterprise adjusted operating profit margins in the 3rd quarter Compared to the Q2 of this year on lower volume and impacts from cost absorption. We also anticipate investment spend will ramp Connectivity in Digital and Electrification. At the segment level, for Construction Industries, we expect a lower margin compared to the 2nd quarter as is typical. This is largely due to lower quarter on quarter volume, increased investment in strategic initiatives And slightly higher manufacturing costs, including a headwind from cost absorption. Favorable price realization will act as a partial offset.

Speaker 3

We also anticipate lower third quarter margins in Resource Industries compared to the 2nd quarter, primarily due to lower volume quarter on quarter. Conversely, we expect 3rd quarter margins in Energy and Transportation will be slightly higher Compared to the Q2 on higher volume and stronger price realization, partially offset by higher manufacturing costs and spend relating to strategic initiatives. Now turning to Slide 13, let me summarize. We generated strong adjusted operating profit margin with a 7 50 basis point increase to 21.3%. We now expect to be close to the top of our targeted range for adjusted operating margin profit margin for the full year based on our expected sales levels.

Speaker 3

ME and T free cash flow Generation was robust at $2,600,000,000 in the quarter. We returned $2,000,000,000 to shareholders through share repurchases and dividends. We now expect M and T free cash flow to be around the top of that $4,000,000,000 to $8,000,000,000 range for the full year. Lastly, we continue to execute our strategy for long term profitable growth. And with that, we'll now take your questions.

Operator

Thank And your first question comes from the line of Jamie Cook with Credit Suisse. Your line is open. Hi, good morning and congrats on the nice quarter.

Speaker 3

Thanks, Jamie. Good morning.

Operator

The real reason you decided not to retire on time because you saw these results coming. That was a compliment. My real question is, the first one, based on your performance in the first half of the year and what you're saying for Sales and margins for 2023, it looks to me like you can achieve the high end of your margin targets around the 21 And we have a question on lower sales versus the $72,000,000,000 target. So do we need to sort of revisit our targets again and adjust the margins on lower sales? I'm Trying to understand what's going on structurally here or is this just all price?

Operator

I think it's important for your story. And then just my second follow-up on 2024, I know you don't want to guide, but you're sitting here with record backlog. I guess you're saying dealer inventories are going to be slightly higher, supply chain is going to ease. What's the probability that you think you could potentially grow your EPS in 2024? Or is there anything out there that's giving you caution, and if so, are you pulling any levers?

Operator

Thanks.

Speaker 2

Well, thanks, Jamie. And as we mentioned in our prepared remarks, We expect our operating profit margin adjusted operating profit margin to be close to the top of the targeted range for the year. We will look at Our range is at the end of the year and make an assessment as to what makes sense moving forward from there. As we look forward to next year and you mentioned some of the dynamics that are going on,

Operator

And we will take our next question from the line of David Raso with Evercore ISI. Your line is open.

Speaker 4

Hi. Thank you for the time. I was curious, the backlog was surprising to me how strong it was. And I'm just curious, any thoughts around the backlog you can help us with In your framework and the guide for this year on how it moves from here sequentially, anything unique in the backlog about What percent of it ships in the next 12 months versus normal? Just trying to get a handle on that.

Speaker 4

And if you could give any early color around Pricing for 2024 with the base order management program opening up this month. Just trying to get a sense of how you're thinking about pricing for 2024? Thank you.

Speaker 2

Well, thank you, David. And certainly, our backlog does remain healthy. We didn't have a dramatic change quarter to quarter. It was Up modestly. And of course, backlog includes, of course, everything for Energy and Transportation Resource Industries And also CI, for the energy and transportation and RI projects that are in that backlog, Those are typically tied to firm customer orders.

Speaker 2

Solar has cancellation charge scheduled. And so again, we feel good about the quality of the backlog. In terms of price for next year, as is always the case, we'll assess market conditions. We look at our input costs and we'll make a call On that later in the year, but it's a bit too early to really predict that.

Operator

And your next question comes from the line of Michael Feniger with Bank of America. Your line is open.

Speaker 5

Great. Thanks for taking my questions. Just a broad question On inventories, when investors hear inventories are coming out, there's always concern on the impact of the margins. There were big destocking periods in the second half In years like 2019, 2015, 2012, what makes this second half of the year different from those other destocking periods? Is it less broad based?

Speaker 5

Is it the fact that retail sales accelerated that gives you confidence we don't have that type of destocking effect that we've had in prior cycles?

Speaker 3

Yes. So at that time, Michael, and thanks for the question. Obviously, we were in a situation where actually demand was reducing when we did Those inventory reductions from dealers. And what that did mean obviously was that production levels were declining much more rapidly, which impacted overall both leverage as well as absorption. As we look out over this period of time, We are still seeing healthy demand as we've indicated.

Speaker 3

We actually still expect positive sales to users in the second half of the year. Well, that does mean is when we are making modest inventory adjustments and dealers are making modest inventory adjustments, we are able to absorb that a little bit better than we have done The whole point about all of this is just to remind everybody, we're around the midpoint of the range. We are actually being proactive with our dealers, Particularly around things like excavators where there's a little bit better availability to actually help them reduce inventory at a time when actually demand remains Very strong out there in the market.

Speaker 5

And Andrew, just to put a fine point on it, obviously, dealer retail sales accelerated in the quarter. To inform your view that dealer inventories for the rest of the year, your comfortability around it, do you expect those retail sales to accelerate? Is that your base case? Is it to moderate slightly and remain positive? Just directionally to give us comfortability with the second half, how are your retail sales outlook in the Informing your view on the inventory levels out there.

Speaker 5

Thank you.

Speaker 3

Yes. So if you actually take the view that we expect Retail sales to continue to grow in the second half. We're not giving you a prediction as to whether they'll accelerate or decelerate. That's all we're going to be saying about that. But just a point is actually with a dealer inventory reduction and with actually increased retail sales, The levels of inventory that actually dealers hold on a month's basis actually would decline by the end of the year.

Speaker 3

That's how the math works.

Operator

Thank you. And your next question comes from the line of Rob Wertheimer with Melius Research. Your line is open.

Speaker 6

Hi. So my question is actually

Speaker 7

on Cat's own inventories. And I know you've got rising sales to deal with, at least so far. I'm curious, are you still holding safety stock on raw materials and components? Is any of the finished goods waiting on completion or is it all just Rising sales flowing through. And then just maybe how much cash could come out of inventory if inventories normalize slightly?

Speaker 7

Thanks.

Speaker 2

Well, good morning, Rob. Thanks for your question. So certainly, we are still seeing supply chain challenges. As I mentioned earlier, there is an overall improvement, But it only takes one part to prevent us from shipping a machine or engine. And so we're still dealing with supply chain constraints around Large engines, which impact both E and T and machines.

Speaker 2

And we also have some issues with things like semiconductors for displays that are impacting other machines as well. So to answer your question, our inventory, quite frankly, is a bit higher than I would like. And I do expect over time, As supply chain conditions improve that we will be able to be more lean and improve our turns. So the good news is that even with Our factory is not running as lean as we would like and having a bit more inventory internally than we would like. We still, of course, produced very strong cash In the quarter, so won't quantify how much cash could come out of inventory, but certainly if in fact we were to when we get back to pre pandemic Levels in the supply chain, we should be able to free up some additional cash.

Speaker 7

Since you answered So well, you look at your margins, it looks like you're crushing operations. And you look at inventory and it's like, well, okay, I understand you've got Some pockets where deliveries hold it up. Can you give you on the totality of how kids managing production flows, factory flow, etcetera, you look at So if you look at other indicators, you do. I mean, what's your assessment? Is this the best you've done?

Speaker 7

Is it are there problem spots? Just an overall look at how Cat is managing, etcetera. I'll stop there. Thank you.

Speaker 2

Well, thanks, Robin. Certainly, I'm very proud of the team and the strong performance that we're producing. We As you know, we put out a new strategy in 2017, and we asked people to have faith in our ability to produce higher operating profit margins And hire more consistent free cash flow, and I'm really pleased the team has been able to achieve that. We always have areas that we can do better. I mean, I talked about the fact that we're not as lean as I would like us to be in our manufacturing operations.

Speaker 2

We're doing a good job growing services, but I always want to grow it faster. So there's always things We can do a better job. But again, just I'm very proud of the team and the fact that we have been able to meet the targets that we set out to our investors a few years ago.

Operator

Thank you. Your next question comes from the line of Tami Zakaria with JPMorgan. Your line is open.

Speaker 8

Hi, good morning. Thank you so much. So going back to backlogs, It went up by $300,000,000 sequentially. What exactly drove that? Was it purely driven by pricing?

Speaker 8

Did you see a net increase in order volumes in the quarter as well?

Speaker 3

Yes. So there are a couple of factors. Obviously, Quarter, obviously, volumes fluctuate by quarter by quarter and depend on availability. But overall, we're pleased the backlog is holding at healthy levels. And maybe just one additional comment

Speaker 2

there. Honestly, some customers are waiting longer for products than I would like. And so a backlog is a function of course of demand, but it's also a function of our ability to ship. So as in fact supply chain conditions ease and we're able to ship more quickly, Customers shouldn't have to wait as long for certain products, which should bring our backlog down. So again, declining backlog Wouldn't be a bad thing if in fact it's the result of our ability to shorten lead times and improve availability.

Speaker 8

Got it. If I can ask a quick follow-up, for the back half, is it fair to assume price realization That's down to, let's say, mid to high single digit growth. And do you have any incremental pricing planned for later this year?

Speaker 3

Yes. So obviously, we've seen very strong price as you've seen through the year. Obviously, we expect that To reduce as we go through the second half, if you take a function of Lacking price increases, I think you get closer to a single digit number. Obviously, we don't estimate that by quarter. But yes, the price Range will come down as we move through the remainder of the year.

Speaker 3

Can I just remind everybody, please? We just ask one question so that we can get through everybody on the queue just out of full courtesy for your other analysts out there, please?

Operator

Thank you. And we will move to our next question from Nicole DeBlase with Deutsche Bank. Your line is open. Yes, thanks. Good morning, guys.

Speaker 3

Good morning, Nicole. Hi, Nicole.

Operator

Just on the retail sales trends this quarter, there was deterioration across like You know both of the machines businesses in EAME. Can you just talk about what you're seeing from that region? I think there have been some indications of a little bit of slowing in Europe. So Would love to hear what Pat's hearing on the ground. Thanks.

Speaker 2

Yes. We have seen a bit of slowing in Europe, as I mentioned, but Middle East is quite strong. So it's a mixed bag there. So, we're seeing a lot of strong construction activity in the Middle East, a lot of non residential construction projects going on, but we have We are seeing a bit of weakness in Europe around construction.

Operator

And we will move to our next question from the line of Steve Volkmann with Jefferies. Your line is open.

Speaker 4

Good morning, guys. Thanks for taking the question. I wanted to just ask a little bit about productivity because I guess I'm hearing you say that supply chain is improving, but there's still issues. Are there still kind of productivity Headwinds or penalties that you're paying in the factories because the supply chain is not yet as smooth as we'd like it to be. And obviously, I'm trying to about whether there's some margin opportunity, when supply chains when and if supply chains are sort of normal again?

Speaker 2

Yes. As I mentioned, because we do have some supply chain constraints, overall, the situation has improved. There's no question. But let's say we've gone to 6 pages of shortages for a certain machine, it's down to 1 page, that's an improvement, but you still have some shortages that you have to deal with And it has not allowed us to operate our factories as lean as we have in the past and as lean as I would like them. So again, I do expect that as supply chain conditions ease in the future, we should be able to get back to running our factories With more just in time manufacturing leaner, which should help us reduce increase inventory turns And reduce the amount of absolute inventory we hold based on a current level of sales.

Speaker 2

So we're showing opportunity to answer your question.

Speaker 9

Thank you.

Operator

Your next question comes from the line of Tim Theng with Citigroup. Your line is open.

Speaker 5

Thanks. Good morning. Just a question on parts. Good morning. Yes, just on parts.

Speaker 5

I guess we can broaden it to CAT Yes, across the board. But specifically, I was interested in the comments in RI for down volumes. Is that just maybe a function of kind of prioritizing whole goods or just in light of the constrained availability or is that I wouldn't imagine there's much by way of destocking going on with the dealers. So maybe just any more comments you have just On that comment on parts volumes and ROI. Thanks.

Speaker 2

Maybe just to start with overall. So certainly, Services sales were up year over year and we have seen fluctuations in dealer buying patterns, which impacts volumes. Services, Dealer sales to customers were up in the quarter and availability of has improved. So our ability to ship parts To our dealers has improved and that has had an impact on it as well. So again, not concerned about it, but it really is just a function of as our availability improves, Dealers oftentimes conclude they're able to held a bit less inventory, which will have an impact.

Operator

And your next question comes from the line of Chad Dillard with Bernstein. Your line is open.

Speaker 3

Hi, Chad.

Speaker 5

Hi, good morning, guys.

Speaker 9

How are you?

Speaker 5

Good. So I wanted to focus mainly on Construction Industries and just wanted to get Better sense of for your orders that came in the quarter, can you just give like a rough breakdown between retail versus stock? And then As you're thinking about like inventory shift, you gave that really helpful stat about 70% is retail for EMC and Resource Industries, could you do the same for Construction Industries?

Speaker 3

Yes. So, when we Talk about it. I mean, obviously, we don't break down what dealers take the orders for between retail and stock In CI, a significant proportion of the purchases they make Based on customer orders, particularly if there is a degree of customization that is needed, and there will be some where Once the machine has actually been delivered to the dealer, they will have a number of things or attachments put on, which will impact the timing of commission. So there's a little bit of commissioning within CI, but obviously, it's nowhere near around the 70% plus that we talk about for E and T And for Leasehold Industries, what we are seeing, as I indicated, is there are patches, Particularly in BCP and Earthmoving, where dealers are constrained and actually would like to have more inventory available to them, And that impacts their orders. So obviously, orders in those segments are those divisions are much stronger.

Speaker 3

Obviously, with excavators and excavators is an impact of what's happening particularly, say for example, in China, where obviously demand is reduced, That means we have more availability and dealers would like to decrease their inventory of excavators accordingly. So it's a bit of a mixed pattern. But as I say, we only have dealers only have 3.5 months of inventory on hand, And that percentage will actually decrease around by the time we get to the year end.

Speaker 5

Great. Thank you.

Operator

Your next question comes from the line of Steven Fisher with UBS. Your line is open.

Speaker 10

Thanks. Good morning. I wonder if you could talk a little bit more about the drivers of the broad oil and gas segment. Where do you think we are In the kind of the rebuild cycle of equipment there, to what extent do you need rig counts to rebound to keep the current levels of revenue sustained? Or Are there really other drivers in this segment to be aware?

Speaker 10

It was obviously a very strong acceleration of sales to users. So just I'm curious for color on the drivers and

Speaker 2

the longevity of this strong trend in the segment. Well, Stephen, we're certainly not dependent upon rig counts to drive Oil and Gas, that's just one element of the one of the many applications that we sell into. So as I mentioned earlier, we are Encouraged by the strong demand that continues for gas compression for Cat branded reset engines, that's quite positive. We have seen a bit of slowing in well servicing, but that's expected to increase again based on most analysts' Sales into a number of oil and gas applications, including gas compression, but also offshore platforms and international Business as well. So again, at this point, oil and gas certainly looks strong.

Speaker 2

And in some areas, we're quite bullish in what we see moving forward. Thank you very much.

Operator

Your next question comes from the line of Kristen Owen with Oppenheimer. Your line is open.

Speaker 11

Great. Thank you for taking the question. I wanted to come back to a question on pricing. First for the Q2, if you can help us understand What's supporting the strength there? I think that was a little bit ahead of where we were expecting price to be.

Speaker 11

Is that a function of mix or just the better than expected And then as we think about that stepping down through the back half of the year to get to that single digit number that you outlined on a previous answer, How we should think about the cadence of that stepping down throughout the remainder of the year? Thank you.

Speaker 2

Yes. So price realization was about in line with our expectations. And certainly, as we look at price, the price we realize is a function of a whole variety of things. You mentioned NICS, but a lot of it has to do with, of course, the competitive situation That we and our dealers are facing in a particular market. So, we saw significant increases in price in the second half of last year That will lap in the second half of twenty twenty three, but we still expect the benefit from positive price in the second half, but it will moderate That's certainly understandable based on that, again, those strong price increases in the second half of last year.

Speaker 2

And as always, we'll continue to monitor the global price environment And we'll determine if actions need to be taken.

Speaker 3

And just, Kristen, just to add on, just if you recall last year price Continue to improve from the 3rd to the 4th quarter, so you probably should see the reverse of that this year, which will price will be slightly stronger in the 3rd versus the 4th.

Speaker 11

Thank you.

Operator

And your next question comes from the line of Mig Dobre with Baird. Your line is open.

Speaker 9

Thank you. Good morning. Just a quick clarification. Yes, good morning. Quick clarification, based on the way you're kind of thinking about the dealer inventory destock in the back half, in order to make that happen, Do you have to adjust production sequentially in any way?

Speaker 9

Maybe you can comment on that. And then related to this, Your manufacturing costs, the $283,000,000 drag, should we think that this drag lessens In the back half and could that actually be a positive benefit as we think about the Q4 on a year over year basis? Thank you.

Speaker 3

Yes. So first of all, on this, obviously, production level, as we indicated from beginning of the year, last year, we did see, If you remember, production was rising throughout the whole year as we went through the year as the supply chain started to improve. That, particularly in construction, will be slightly different this year and that obviously we will see some headwind as we do see some dealer inventory reduction in the second half. We are already making production adjustments as we move on. That's part of the business.

Speaker 3

We do that day in, day out, And those will continue and there will be some impact in the second half of the year. But overall, still expect positive revenues Through that period of time, for Caterpillar as a whole. Talking about manufacturing costs, yes, manufacturing costs will decrease, Obviously, price benefit will reduce as well. So the net of the 2 will mean we won't see quite that margin improvement That we did see as we went through the last four quarters. So yes, we still expect Price to offset manufacturing costs in the second half of the year, but they won't that whilst that will reduce silver price as well.

Speaker 3

So No real benefits margins as we think through the remainder of the year.

Speaker 2

And just to expand upon the answer, we talked earlier about the fact that there is enough Excavator dealer inventory out there. So we certainly would expect to produce less excavators as an example in the next 6 months. Also mentioned the fact that we're going to have some changeovers in some of our BCP products where we're switching to CAT engines, which is certainly the right thing to do for a long time and growing services. That will have an impact on production as well during the last 6 months of the year. But keep in mind that we have said, we now expect to be close to the top of our targeted

Operator

And your next question comes from the line of Mike Schliskey with D. A. Davidson. Your line is open.

Speaker 12

Yes. Hi, good morning and thanks for taking my question.

Speaker 2

Good morning.

Speaker 12

Good morning. So historically prior to the pandemic, your operating In the Q4, we're usually a bit of a step downward compared to the Q3. That's mainly Construction and Resource. Things got a little off pattern in the last couple of years, obviously, for a few reasons. But I was wondering if you could tell us whether you'll be back to that sort of more normal seasonality on margins here in the second half Of this year or if operationally, things have kind of changed permanently here?

Speaker 3

No. I think that definitely we would expect a Step down in margins in the Q4 in both particularly in construction as is the normal seasonal trend. It does tend to be the lower production period. Also, on May June, again, just as Jim mentioned, we will have the impact of the BCP changeover, Which will impact us slightly more stronger in the Q4. So that will be some impact as we move through the Q4.

Speaker 12

Thank you.

Operator

And your next question comes from the line of Matt Elkott with TD Cowen. Your line is open.

Speaker 5

Good morning. Kind of a higher level question on non residential construction. Good to see the tailwinds of the infrastructure packages Can you help us gauge what innings you think we're in with these tailwinds? Can we expect to Like an acceleration next year or just steady? Thank you.

Speaker 2

Yes. Thanks for your question. I'm going to try to avoid a baseball analogy here. But As I mentioned earlier, we are starting to see some benefit of the numerous infrastructure bills that are passed. Some of that is coming from the states, but as you can imagine, permitting takes time for a number of projects.

Speaker 2

And it's, as you can imagine, very difficult To judge exactly how long that permitting process will take and how this will play out, but I do expect it to last for some time. Difficult for me to estimate, all right, what will the Acceleration being a 6 month or 1 year period, but again, it's a very positive thing for us and it's a positive thing for our customers that we have these projects Coming down the pipe.

Speaker 5

Thank you very much.

Speaker 2

Thank you.

Operator

And your next question comes from the line of Stanley Elliott with Stifel. Your line is open.

Speaker 6

Hey, good morning, everyone. Thank you all for fitting me in. Quick question on the cash flow. You guys have pretty been consistent about discussing returning all the free cash. You have basically, let's call it another kind of $4,000,000,000 $5,000,000,000 run rate in the back half of the year.

Speaker 6

Should we think of all that going back to share repurchases or using for other investments? Any thoughts there would be great. Thanks.

Speaker 2

Yes. As we said, our intent is to return substantially all of our MAT free cash flow to shareholders through dividends and share repurchases over time. We do maintain a healthy balance sheet for a whole variety of reasons. When we went into COVID in 2020, I was very pleased that we had a strong balance sheet. We also have increased our dividend since we introduced our new Capital allocation strategy in May of 2019, we've increased the dividend per share by 51% since that period of time.

Speaker 2

So again, We're proud of our risk strat status, so certainly wouldn't be surprised. It's a Board decision, but if we continue to increase our dividend And continue to share repurchases as well.

Operator

And today's final question comes from the line of Jerry Revich with Goldman Sachs. Your line is open.

Speaker 13

Yes. Hi. Good morning, everyone.

Speaker 3

Good morning, Jerry.

Speaker 12

Jim, I'm wondering if you

Speaker 13

could just expand on Your comments in mining, your biggest competitor in trucks is posting 2 50 percent book to bill. I'm wondering if You're seeing that level of bookings activity and are we finally at a point where we're hitting the sweet spot of that Replacement cycle for what we delivered a decade ago or are there some idiosyncratic ebbs and flows in the data points? Thanks.

Speaker 2

Well, thank you. Thank you, Jerry. And certainly, as we've talked about many times, mining is kind of a lumpy business quarter to quarter. And our mining customers are remaining capital disciplined. What we've talked about for some time is what we expect is a gradual increase over time In our mining business and that's certainly the way it's played out.

Speaker 2

Certainly, at the moment, large truck sales are Activity that activity is robust. That quotation activity is quite robust and some other products not quite as strong. But again, just based on what we see Required in terms of commodity production increases to support the energy transition. We feel very good about that business. We do believe Quite strongly that we have the best autonomous mining solutions.

Speaker 2

We now have about 600 autonomous trucks in operation around the world. And one of the great things that's happened Is that we've been able to reduce the cost such that now a smaller mine can make a capital investment to put autonomy. And When we're talking to miners now, autonomy is almost always part of that discussion. We're down to about 12 to 14 trucks. If a mine has about So the 14 trucks, it could pencil to put autonomy and we've actually seen mines adapt autonomy with that low number of trucks.

Speaker 2

So we're quite bullish about what we see coming in again. And we're leveraging that autonomous solutions, whether it's in iron ore, copper, gold, Oil Sands, a whole variety of applications. But again, we're certainly long term bullish about that business. All right. Well, if I can, I'd like to thank you all for joining us and we certainly appreciate your questions.

Speaker 2

Again, I want to thank our global team one more time for just an And to reiterate, based on our strong operating performance due to the strong results that we achieved in the Q2, we now believe that 2023 will be even better than we had previously anticipated during our last earnings call and includes higher full year expectations for adjusted operating profit margin and E and T free cash flow, Which again reflects that continuing healthy customer demand in our performance. Please stay safe. Thanks for your interest.

Speaker 1

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 second quarter results video with our CFO and an SEC filing with our sales to users data. Click on investors.

Speaker 1

Caterpillar.com and then click on Financials to view those materials. If you have any questions, please reach out to Rob or me. Investor Relations' general phone number is 309-675-4549. Now let's turn it back over to Abby to conclude our call.

Operator

Thank you. Ladies and gentlemen, that concludes our call today and thank you for joining. You may all disconnect.

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Earnings Conference Call
Caterpillar Q2 2023
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