Thank you, everybody. Good morning. Our first presenter, doesn't need an introduction. Dow 30, Caterpillar. We all know them and love them, obviously happy to have him here. Really appreciate it. We have Matt here from investor relations.
Ryan.
I mean, sorry, Ryan. Sorry, I was saying Matt. Ryan, really appreciate you being here. Very helpful to have you, and look forward to spend more time with you on a regular basis. Andrew, I remember when you first started.
Yes. I think you were my first meeting, David.
I think it was. We were a little younger then. It was only five years ago. Yeah. Ryan, I'll kick it off to you for a few minutes and then we'll.
Great.
Talk with Andrew.
Yeah. Thank you very much, David. Really appreciate the opportunity-
Appreciate it.
...to be here today. I'll just kick it off with the Safe Harbor statement here. During today's discussion, 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 from the information we're sharing with you. Please refer to our recent SEC filings and the forward-looking statements reminder in our news releases for details on factors that individually or in aggregate could cause our actual results to vary materially from our forecast. A detailed discussion of many factors that we believe may have a material effect on our business on an ongoing basis is contained in our SEC filings. We'll also refer to non-GAAP numbers. For reconciliation of any non-GAAP numbers to the appropriate U.S. GAAP numbers, please see the appendix of the earnings call slides. With that, I'll turn it over to you, David.
All right. Thanks, Ryan. I appreciate it. Not quite exactly five years.
Close
...just about. Just about. And one of the first, you know, CAT executives from the outside. When you came in as CFOs, it was interesting to get a perspective from you when you first came, like, you know, what do you think the Street maybe doesn't appreciate about CAT? Things that you looked at to make the move over.
Mm-hmm.
I remember you highlighting particularly the, I think the Street underestimates the cash flow of the company.
Yeah.
You know, I went back and you looked at the numbers. I mean, you realize pre-financial crisis, this was, you know, 5% free cash flow as a percent of sales. It had a pretty good run, about 9%. I think people weren't sure. As you said, since then, we've cemented that we can do 9+ % free cash flow margin. When you think about the next, say, 4 or 5 years, the investment cycle versus maybe some opportunities to improve the cash flow. Can you take us through when we think about that sort of 9%? Not trying to hold you to a target, but have we sort of reached that level that we can maintain or maybe even improve, or there's some investments coming up that might make it dip a bit?
I mean, I think one of the, you know, back exactly. I mean, one of the things I found very interesting is obviously everybody was very focused on cyclical earnings in a cyclical company like Caterpillar Industrial. One of the things I was surprised at was the consistency of the cash flow. Cash flows are strong even in relatively weak periods of for the business. In fact, you know, even in 2020, when we made some conscious decisions to continue to invest in inventory, we still generated over $3 billion of free cash flow. I think that's always to me has been the underappreciated part of Caterpillar. Why is cash flow so much stronger than even if you look through the historic trends? I think there are a couple of things.
One, obviously, that focus on the flexible cost structure has been really, and competitive cost structure has always been key, to making sure improves obviously operating margins, but obviously also make sure that we generate additional cash associated with that. The second most important is really the discipline that comes around from parts of the O&E model, particularly around investment thesis. You know, Caterpillar had a track record, I think, is well known of chasing the cycle, and investing, even in when people were sort of sitting there going, "Well, maybe it's not the right time to invest." In order to attain the last highest unit of machinery that could be sold at the peak of the cycle, we had capacity. We're not doing that anymore.
I think that discipline has been really important as part of that, because what it does mean is we've not overinvested in assets, which again, just helps from a cash flow perspective. Area where I think we have an opportunity over the next couple of years is particularly around working capital. We have obviously, through the challenges of the supply chain difficulties over the last 18 months, 2 years, what we have done is we've allowed inventory to rise to a slightly higher level. There is still an opportunity for us to generate a little bit more in the next couple of years. The other side, from an investment perspective, probably not so much in bricks and mortar investment, needed as much as investment in things like new technologies.
That's the capacity we have to make sure we are able to invest in those new technologies, be it, you know, electrification, hydrogen for using as a power source. All of those things need investment, and that will be part of where some of our CapEx will go.
The thing about the CapEx, right, it was running, call it 4+% historically as percent of sales. The last five years, even though working capital has been a little more of a struggle given the pandemic, your CapEx has only averaged, I think, like 2.3% of sales. It made up for a little bit for the working capital.
Mm-hmm.
Now we look at, and I noticed when you put, Kim put out the last release and you at least brought in the revenue potential to $72 billion. I know it was more inflation than it was unit-driven, but still, the idea of a Dow 30 company 10, 11 years since its last proper peak, the revenues are still not back to where they were. When I think about the ability to serve the next cycle, when you were doing $63 billion of equipment sales 11 years ago, the PP&E was $13 billion. Today, it's only $8 billion.
Yeah.
You've been able to turn those fixed assets very well. To get to a $72 billion, and, you know, some would argue, maybe we can do $80 billion. To not have to invest in PP&E, you would be suggesting, I mean, absolute best-in-class asset terms. For staying at $8 billion PP&E, can we really serve a $75 billion-$80 billion dollar base, or is there some brick-and-mortar maybe investment that's needed?
Yeah. Obviously, as you reflect, a part of that is the inflationary outlook, which does have an impact on asset terms. Obviously, you got a lot of historic assets, which, some of which are accelerated from an accelerated depreciation perspective, have very low, relatively low values, but actually are still very productive today. It's more about maintenance CapEx relating to a lot of that. I'll remind you, the Investor Day in 2019, we talked about the fact that we were running at about 70% capacity utilization at that stage across our network. If you look actually probably today, unit volumes are probably not, you know, no different from 2019.
We're not back even at that level yet from a unit volume perspective across the organization as a whole. What that does mean is that obviously capacity utilization still probably is at a similar or lower level. There are always gonna be bottlenecks. There are always, obviously, for certain products, for certain lines, there are always gonna be investments that need to be made. I mean, we're investing about a billion and a half of CapEx this year. We think that's about the right level. You know, we do not, we're not sitting there constraining people from coming up with ideas if they're willing to and they achieve above the cost of capital 'cause that's the whole discipline about using the OPACC model.
Obviously, we will make those investments, but at this stage, we just don't see the need. Yes, you know, possibly we will be able to make those sorts of asset turns. Again, one of the things, again, Caterpillar has a very high return on invested capital. One of the advantages of being a, effectively a company that's grown by organic means and obviously not from M&A particularly, means that our returns are very high as well. Again, that's also another factor back to the cash flow discussion, which I think is a characteristic of the business, particularly being that it is something really where the growth has come from internal development rather than actually going and acquiring companies on the outside or acquiring businesses.
Yeah. I mean, you know, clearly right now, I always say cyclical trumps secular. If you have the cyclical to keep the PP&E this low, then you would argue, right, if you're growing the parts and service, the incremental returns on capital, if the cycle prevails, should be rather significant.
Yeah.
Because to keep the PP&E that low--
Yeah
... 'cause if you're saying you're only 70% capacity utilization, roughly, that suggests we can do $75+ billion of revenue off the current base.
You know, we're not sitting here today looking at major investments needed in capacity utilization. There's nothing for us today which says, "Wait, hold on a second. This is something which is gonna drive us needing to think about capacity." I mean, we have stopped, probably ended most of the program of actually reducing manufacturing capacity, 'cause I think that is in the past. I mean, obviously, some of those challenged businesses, we'll still look at how we manage those particularly and how we move those products around to optimize the cost structure. Actually, from a capacity perspective, you know, I'm not sitting with a pile of proposals sitting on my desk saying, "Here's a ton of money we need to go and spend." It, you know.
You know, at this stage, it's, you know, those returns will flow through. That will help cash grow, help returns on invested capital, all good things from a shareholder perspective.
Two things it strikes me then if, again, cycle prevails, we'll see, right? You're gonna have very strong cash flow. You're not gonna have to really invest a ton in the business. Two things. One, you've obviously grown the dividend now high single-digit for many years, kinda cementing the Dividend Aristocrat, so to speak, you know, title. When I think about the balance sheet, covered the company for a little while, and it was always at least one half the EBITDA term.
Yeah.
It was sort of the... I'm not saying that was high. That's-
Yeah.
Now you run 0.3, 0.4 the last, you know, 10 years.
Yeah.
The Great Financial Crisis put fear in a lot of people, I get it. 10 years later, with this cash flow profile, doesn't sound like there's a big investment cycle coming. The dividend, you're already, you know, cementing, I think, enough of a dividend increase we can argue.
Yeah.
How should we think about the balance sheet and future cash flow and what you're looking to do with it? At least history would suggest CAT has those moments of big M&A, like the late 90s, building out the engine business. You know, we can debate some of the timing on some of the mining and Chinese acquisitions. You say, well, that sounds like every 10, 12 years. Are we due for an M&A cycle or I would say ideally just buying back a lot of stock?
Yeah. I mean, I think, obviously what we've done over the last several years is buy back a lot of stock. If you think through last year again, and as well, you know, I think one of the things, the priority has been obviously, to return substantial free cash flow to shareholders, leave the balance sheet available, as best, you know, as there is a buffer for, you know, probably The likely size of M&A is much more likely to, for us to be something like a Weir and smaller rather than Weir and bigger, and SPM, when we acquired it.
Because ultimately, at the end of the day, you know, one of the things we've found, and if you, if you look through the history, the, you know, adding incremental product isn't necessarily always the optimum return for shareholders through Caterpillar. Obviously, we've done some successful M&A, but some of it has been less than successful, less than stellar. Keeping the balance sheet free is really around making sure where we are needing things. A lot of the things we're doing are really about things like capability today. CarbonPoint, which is carbon capture and storage, which is a small acquisition, but it's just to give us access to that technology.
Tangent electrical services, which is around providing services to customers who own gensets and actually then can monetize the value of that genset on a more regular basis. things like Lithos for battery technology and battery packaging, which obviously is gonna be something which we need to gain capabilities on. All of those things are part of this holistic view, I think, of looking at where do we need to add capability, and that will be the accelerator from a balance sheet perspective. Always on the balance sheet, what I always remind people is the ME&T balance sheet doesn't have a lot of net debt, but I do have a captive finance company sitting on the other side.
It does have $30 billion of debt associated with it. Rating agencies tend to look at both together, so you have to be a little bit careful not just to think about on the standalone basis. Yes, I mean, obviously, you know, if we end up generating a lot of free cash flow, and we've shown that, we'll be buying back a lot of stock probably.
It does feel like your free cash flow margin has a chance to improve if I can grow off the same asset base. Working capital we can debate, right?
Yeah. It, I mean, obviously it depends on investments in other areas like working capital and so forth w hich are needed in that, in that context. Yes, there is always an opportunity for us to continue, just the same as we do with margins, use the leverage we're gaining from the top line to leverage cash flow returns. We should be thinking on that same, exactly the same context.
Do you have, and you weren't even there at the time at CAT, but the scar tissue from 2008, 2009, where, you know, CP markets froze for a bit and the whole bit? Are we comfortable though running? 'Cause it's not like the debt to equity-
Yeah.
-on CAT financials, particularly with high versus history. I would say back in the day when CAT was investing in, like, owning, like, a power plant to sell CAT engines, it's probably less of a risk profile today. Even half an EBITDA turn is $6.5 billion.
Mm-hmm.
Which is a lot bigger than we are.
Yeah.
Are you saying we should expect the leverage on the equipment company to stay at that level, or is there a little room to use some balance sheet for share repurchase?
We did last year. For example, last year we actually spent more than... It was a little bit more, and that gives us the flexibility to be in that. You know, I think, the probability of us, you know, you know... I think, you know, last time we had this conversation, was in May 2019. Probably come March 2020 when COVID hit, I can tell you I was very glad to have a very pristine balance sheet.
I know.
The first thing we did through COVID was spend a lot of time doing the risk management approach of what is the worst case scenario if we don't sell any machines for a period of time.
Yeah.
I think always, you know, There is a balance to be had. I think, over time, priorities may change. Yes, there may be an opportunity. It's always about having that flexibility, I think, which is the most important thing.
Diving into the businesses a little bit. The mining cycle. Orders have been healthy but not super robust. It does feel like a cycle that might have more durability to it. Excuse me. Given that you're serving customers really trying to solutions, but also having to reduce their emissions footprint. Even today, a diesel truck today is a lot cleaner than the one they bought 15 years ago. What you're seeing in the mining cycle, the, I would argue, restraint on the orders, but you're also doing more retrofits and the ecosystem's getting bigger maybe with new technology. Can you discuss, and doesn't sound as if investment need it, the mining cycle. Is it coming across to you as I've got legacy e-energy, I've got new energy to serve? Is this a more durable cycle than we've seen in the past, you'd argue?
Is there maybe a little more of a hockey stick still potentially left to it based on some of the conversations with big customers and Denise running the business?
Yeah. I think, I mean, one of the things, you know, we've seen is a very steady re-recovery of the mining market, particularly. That has been, as we've said, you know, slower and steadier than probably it has been historically. You know, there's a lot of activity going on. There's a lot of quoting activity, and if you look at the average age of trucks, they continue to age.
Ultimately, at the end of the day, we're not yet at the replacement point where actually the truck fleet age is actually declining, which is when you would say, "Okay, you're at the right point from a aging of the fleet perspective." You know, what's happened obviously has been a lot of focus on rebuilds, a lot of focus on using the equipment as much as possible, from a miner's perspective. Ultimately, at the end of the day, we do believe that there will be a long and more sustained cycle than there has been historically. That would be better for us, so we'd be very much more focused on that.
The wild card always here is does something happen which causes people to invest much more quickly than has happened in the past? If you look at the capital discipline that's there within the mining sector and within the oil and gas sector, for example, both of those are showing constraint versus historic trends, where given the outlook and demand for both, you know, oil and gas and for commodities, you would expect people to be sanctioning a lot of projects at the moment. They're not.
Yeah.
Part of that is this desire for capital constraint coming a lot from investors, which has impacted those companies. That actually is not a. I think that's a good thing for us. A, first of all, because we do believe our total addressable market will grow as a result of the energy transition, and B, also, because basically that is a much more steady ramp, a much more steady-state, rather than the boom bust that we saw in the last super cycle. Which obviously had huge implications because you suddenly went from, you know, a large order book, huge number of large mining trucks being produced to virtually zero overnight. That was obviously quite.
I would think in that environment too, we don't need the units back to the old level to achieve the same margins as the last peak. Is that a fair assumption or?
Yeah. I mean, there'd be some... I mean, obviously, you know, we are very focused on making sure that we have the right cost structure in place. You know, lean manufacturing and so forth always tend to help. You know, on a margin basis, it's hard to just, you know... Margins are a factor of a lot of things within some of our businesses. Mix, mix between services and OE, where it's going in particular, you know, with geo-mix impacts and so forth. A lot of that, those things play out. Yes, the margin outlook for resources will be positive if we continue to see a steady growth within the business.
Speaking of profitability of the CI business, I think I would have lost a bet 20 years ago saying, "This business can run double-digit quarter after quarter, year after year, let alone 20%." 20% makes me a little nervous that something like that's sustainable. It feels like at least near-term, what we're hearing on used prices and a wide variety of commentary from competitors, and we saw Komatsu and Hitachi talk about price increases as well. The idea that CI margins have peaked at this level, is that something you would say isn't necessarily true or is it just, it's high enough now it'll be hard to run the business at that level, even just over the near-term?
Yeah. I mean, I think you've got to be careful about looking at one particular quarter.
Sure
... versus looking at the overall, margin structure for the year. I mean, what we did see in the fourth quarter, was very strong margins for a couple of reasons, within CI. One, because obviously we're still recovering the price and the cost increases, so that still was trying to get back to where we were, as we said, overall across the company. We're still only just getting back to 29 gross margin, 2019 gross margin. You know, we've only just been in a situation where we're starting to recover, some of that. That was an impact, and obviously we took the pain earlier in the year, hence the very unusual margin structure in CI last year.
As you quite correctly pointed out to me, you normally see margins improve in the first quarter and deteriorate by the fourth quarter. Why can't we see improvement in the first quarter of this year versus the fourth quarter of last year? Part of that is just purely because we're still going through this you know, the lingering impacts of that supply chain impact, and also volume was pretty high and we're producing as much as we can all the time, whereas normally we'd be slowing down in the fourth quarter, which impacts volume variances and therefore impacts margins. Yeah, I mean, I, you know. I mean the challenge within CI, you know, again, there's gonna be a mix impact as well, just as much as anything else.
What peak parts from machines, what machines are selling. Obviously North America is very strong. That's a very strong market for us. That helps. All of those things are part of that equation which have to be thought through. Obviously, the challenge now will be if we start seeing material costs decline, holding as much of the price as we can. That will be the challenge which will come. You know, that'll be what we've done historically. We'll be focusing on that.
In the first place, would ever see any give back in price would be just bump up the incentives a little bit for the dealers? I mean, it wouldn't be obviously a retail sticker going down.
No. I mean, you won't see that, but obviously there's always an amount where you can look at and, you know, if you're in a competitive situation on a competitive deal.
Mm-hmm
... you obviously could provide some variance in those regards. The reality is obviously we've been very disciplined so far and actually managed to realize a huge amount of the price that we have had out there, and part of that is because everybody's in the same position that we are as far as being relatively constrained from a supply chain perspective. Obviously, that dynamic may change at some stage. Again, that will be part of the equation we have to look at.
Yeah. It seems so far year to date, you're still hearing about pretty resilient and if anything, people pushing price. I mean, you see some of the steel prices-
Yeah
... going back up, so.
Yeah.
When it comes to the engine business, oil and gas, you can't help but notice on the balance sheet, the customer advance line's strong. I usually think that's at the Turbine strength.
Yeah.
Can you take us through what you're seeing on oil and gas onshore versus offshore?
Yeah. Obviously, the onshore business, and onshore oil and gas, I would add a little bit of power generation in here as well 'cause probably the two are, particularly from a reciprocating engine, there's a bit of an overlap in where the engine demand is. Obviously things like the 3500 and 3600 series engine demand is very, very strong. Part of that obviously is onshore oil and gas. Whilst we aren't seeing increases in wells, we are seeing obviously the fact that obviously machine, the engines have been run down, they've used the existing fleet, they're now needing to replenish, that's where the investment's going. That's a positive for us. Obviously demand is very strong there. Within Solar, demand has been very strong.
There seems to be a little bit more offshore as you indicate. A little bit around LNG as well, 'cause obviously, gas compression is a factor within Solar. Again, I think, yes, the markets are coming back quite strongly. Obviously, not as strongly as you would normally see with the oil price being the level because again, back to that point about capital discipline, there is an element of capital discipline being displayed, which is positive again for the longer term because of what it means is avoiding the boom-bust type cycles that we seem to.
We haven't had much of an offshore cycle in a while.
Yeah.
I'm generalizing, of course, offshore margins versus onshore. How would you characterize as an analyst? Is that a positive mix or...
I wouldn't be able to tell you.
Neutral? No.
I'm, unfortunately, I wouldn't be able to.
No, no worries. comment as you wish. UAW.
Yeah.
Um, so the vote-
Yeah
...is coming up.
We've got the vote to come through. Obviously, we'll, you know, we'll see whether the deal gets accepted. It's obviously, a relatively small proportion of the overall manufacturing profile of the company. Obviously we continue to have contingency plans in the event that the deal is not accepted. Hopefully, you know, we'll get a deal. Obviously they've got a tentative agreement. It's, it's really about the vote, and we'll only see that after the weekend.
Yeah. I mean, at least the numbers we've seen around it, because the precedent's sort of been set with the prior strikes we've seen, the bid ask between what the rank and file would expect from their leadership and from the company, it feels like the bid ask is narrower, right? There's some precedent set. I think even the time taken from the agreement to getting the vote shows a little more patience with making sure the rank and file knows what's in the agreement. Obviously, you have to manage for, right, you know. The level of inventory going into this, I assume there was just obviously some conscious idea of like, hey, if we do have a strike, the inventory build going into it, I assume provides some coverage. I mean, any way to sort of quantify a little bit the-
No, I mean, it's not. I mean, there is, there will always be a little bit of a buffer. Ultimately, at the end of the day, you know, there is risk that we have contingency plans to manage that risk. It really is around hopefully ending up with an agreement that everyone's happy with. If, you know, let's see how the vote goes. I mean, I think it would be wrong to speculate until we see that. It's a few days away.
Second, I think a lot of investors were surprised to hear, kind of a constructive end user demand outlook, but then no inventory build. I think a little bit definitionally.
Yeah
...most people go, "Oh, going into the rental fleet for the dealers." Well, I think that's inventory.
No.
You count that as sales, right?
Yeah.
Can you just, not to pin you to a number, but when we think of how much is a refresh of the dealer rental fleet this year, which for most people would view as it's a wholesale rebuild of the channel?
Yeah
...right? I don't need retail demand as much. Is that $1 billion, a billion and a half? I mean, just to put it in perspective, the number of people thought they'd get out of inventory build this year, you're getting it more on a rental channel.
Yeah. I mean, I think, one of the things, and so just, we, you know, we don't specifically forecast a number of exactly what we think will go into the rental fleet. Part of the reason for that is, at the moment, we're still saying to dealers, prioritize customers of customer demand over your rental fleet. It really is a sort of, it's a little bit of-- It's almost like if demand softens slightly, that will be offset. You know, as you say, third party end user demand rather than rent, that will offset the, and be used by effectively dealers replenishing their rental fleet. It's a little bit of a, you know.
It's one of those things which is very difficult to exactly predict given that we are still you know, feeling some constraints. We're not 100% through all of this. Things are obviously better, particularly in CI than they have been, but there's still issues there. That means that obviously we're sort of trying to watch this, but prioritize and tell dealers the priority must be end user demand first.
Is there any number you can adjust that?
No, I think, you know, the point I would say is obviously we're still expecting volume demand from a STU perspective to increase, to grow this year. We'll keep monitoring that as we go through the year and sort of like try and give. I don't think, you know, it's not a, you know, it's not a big enough number that I would call it out at this stage. It may become a big enough number, and then we'll probably end up talking about it. 'Cause one of the things always there to remember is, you know, and this is one of the things, you know, hopefully we're trying to do a better job at, is trying to tell people about things like dealer inventory movements quarter-on-quarter and so forth.
Obviously, if you do have a rental build, and we do go through the year and we do see it, and we'll talk about it by the end of the year, is that will obviously be a factor when we look at 2024.
Sure.
All of those things, which is why we just reminded everybody what happened in 2022 from a dealer inventory perspective. You know, remember that of the, you know, $2.4 billion of inventory build, only about 40% of that was actually CI. Most of the rest of it related to RI and ENT, and most of that was direct customer orders, which just for a number of reasons, just had not worked their way through the supply chain, about 70% of those. Again, it's just trying to give you the sort of facts to sort of work out and then actually get an underlying growth sort of expectation based on the data we're.
A quick small one. The other income line last quarter, right?
Yes.
The dollar has strengthened.
Yeah.
I assume that's a plus. I mean, it's not a huge number, but the idea of the dollar weakens in the fourth quarter, your net liability position international, and you have the balance sheet adjustment in other income.
Yeah.
The expectation was this first quarter, we'll have another maybe negative adjustment.
Yeah.
officially, for the like quarter to date, the dollar's a little bit stronger.
Yeah
...especially the last month. Does it work that quickly?
Yes, it will do.
Okay.
It will work through pretty quickly 'cause it's a balance sheet translation adjustment.
Yeah. It's whatever it is March 31st.
whichever it is at the, at the month end. Depends what it is on the 31st of March will drive what that number is for the quarter. It's a very interesting, you know, point, which is one of the challenges with this is OINE. You know, there's a whole lot of things within the other income and expense, and they have been trending about $250 million-$300 million income for the last, you know, for seven of the last eight quarters. Fourth quarter, it just switched like that, and it switched very close to the quarter end, which is part of the reason why we did have the big number. It's a little bit of an accounting nuance as well.
This is functional currencies for overseas entities. If you treat them as dollar functional currencies, you then have to take translation losses, gains and losses through OINE. It's a decision that was made many, many years ago. Probably one that I would look back and say probably somebody didn't understand exactly the consequences of it, 'cause normally all balance sheet translation just goes through the below the line.
Yeah. Agree.
It's one of those things. It probably makes intercompany accounting on transfers, which is one of the entities involved in a lot of the transfers and a lot easier, but it probably does have some surprising consequences which you can't factor in, and dollar movement was quite significant.
Yeah. It's a little bit of goodness for the, for the first quarter. I mean, talking about driving forward, but-
It may be. It may be.
We're basically out of time. I apologize. Any questions from the audience for Caterpillar? I think we covered everything then. All right. Thank you so much.
Okay. Thank you very much, David.
Really appreciate it.
Thank you. Thank you.