Equity Research

Industrials Market Weight

September 7, 2016

CATERPILLAR, INC. (CAT $82.08 SELL)

Attempting To Fool All the People All the Time Paints President Lincoln A Fool
Is CATs Upcoming (i.e., 2-3 months out) 17 Sales Guide a Black

Swan? Using math/history, the answer to this question appears to be

yes. That is, when looking at the ratio of CATs backlog expctd to be
shipped over the next 12 months at each yr end divided by its annual
rev guide provided the following Jan. (Ex. 6), over the 02-15
timeframe, on avg., the backlog expctd to be shipped 12 months is
26.6% of next yrs sales guidance. Thus, taking the $7.6bn of backlog
CAT expects to ship over the next 12 months, as per the 2Q16 10-Q, &
assuming this figure remains static thru yr-end (even though CATs
backlog has seen a consistent slide since peaking 1Q12, & fell -9.9%
QoQ in 2Q16; Ex. 32), then adjusting for 26.6%, one arrives at implied
17 sales guidance of $28.6bn, or 27.7% below the Street (Consensus
$39.5bn). Even when modeling this metric in the low 20s (the lower this
number goes, the higher the inherent risk in CATs rev guidance as it is
not backed by estd. fwrd 12-month shipments out of backlog) which
has only happened twice (i.e., 03 when it was clear we were entering
an EM commodity super-cycle & 09 when China had just embarked on
a CNY4tn stimulus targeted at infrastructure & we were exiting the
great recession) CATs implied 17 sales guide is $32.4bn, or 8.4%
below Consensus. With the factors prevalent in 03/09 virtually nonexistent today, we see CATs 17 rev guide as a real/n-term risk.
Is Down-Cycle Compelling Accounting Chicanery at CAT? First,
looking to CATs RI seg., weakened mining CAPEX appears to be a
mean reversion, rather than a temporary event, implying the equip.
resurgence ingrained in fwrd. Street EBITDA ests. is not coming.
Further, w/ a sizeable amount of used RI equip. avail. (Ex. 12), we see
contd margin pressure as likely. In the E&T seg., w/ energy CAPEX
still correcting (Ex. 1) & near-record inventory of locomotives (Ex. 18),
we expect contd headwinds. Moving to CATs CI seg., w/ a bolus of
avail. for sale equip. & persistent price pressure, contd margin erosion
seems a given. Finally, looking to CAT Fincl., w/ exposure to a number
of distressed cos, aging A/Rs, & a likely reversal in 2H15 released
reserves, we see costs rising. CAT has responded by aggrsvly
adjusting pension acctng in its favor & hiking restructuring allowances,
both inorganic boosts to non-GAAP EPS, inspiring our reports title.
Val. After factoring the above analysis into our model, our Street-low
ests. edge even lower (see below). Our 17 yr-end PT is $31/shr (63%
downside), applying a 12x EV/EBITDA multiple to our 17 EBITDA est.

Gordon L. Johnson II
Senior Analyst/MD
212-521-3811
gjohnson@axiomcapital.com

James A. Bardowski, CFA

Senior Associate/VP
212-521-3852
jbardowski@axiomcapital.com
Fundamental Data
Price Target
Current Price

$82.08

52 Wk Hi-Low

$85-$56

Market Cap. ($MM)

$48,312

Shares Out (MM)

589

Float (MM)

583

Avg. Daily Vol ('000)

2,862

Exchange

NYSE

ROE (2016E)

8.9%

Debt-to-Capital (current)

71.5%

Dividend Yield (trailing 12 month)

3.8%

Price Performance

YTD

LTM

CAT

20.8%

12.3%

S&P 500

6.8%

13.6%

Price Performance 3YR (USD)

$120
$100

EPS (GAAP)

2014

2015

Prior

2016E

Prior

2017E

1Q

$1.44

$1.81

$0.51

$0.46

$0.59

$0.17

$60

2Q

$1.57

$1.16

$0.74

$0.93

$0.63

$0.32

$40

3Q

$1.63

$0.62

$0.56

$0.50

$0.44

$0.22

$20

4Q

$1.23

($0.15)

$0.34

$0.29

$0.35

$0.13

$0

FY (Dec.)

$5.87

$3.50

$2.16

$2.19

$2.02

$0.84

$3.34

$2.81

$3.34

$3.46

Consensus

$31

$80

2013

2014

2015

2016

Source: Company data, Bloomberg, Axiom Capital Research.

Source: Company data, Bloomberg, Axiom Capital Research.

DO NOT REDISTRIBUTE and DO NOT FORWARD This document is solely limited to clients of Axiom
Capital Management. DISCLOSURES: Please refer to the end of this report for Analyst Certifications,
Important Disclosures, and Other Disclosures.

Caterpillar, Incorporated
September 7, 2016

Investment Conclusion
While CATs shares are up 20.8% YTD, they have actually slightly outperformed our custom Axiom Capital
Research Industrial OEM Index (URI, AHT, HTZ, HEES, JOY, CAT, FENR, ASTE, Doosan, ATCOA, SAND,
Komatsu, Guangxi Liugong, Sany Heavy, RR, CMI, SIE, and DE), which is up a weighted-average 20.4% YTD.
Yet, when comparing CAT to our Axiom Capital Research OEM Steel Index (X, AKS, MT, CMC, NUE, STLD,
RS and WOR), which is up a weighted-average 60.5% YTD, a drastic underperformance emerges. And, CATs
YTD performance is also trending behind our Axiom Capital Research Mining Index (RIO, CLF, FMG, BHP,
VALE, MGX, GBG, SID, and CAP), which is up a weighted-average 42.2% YTD. However, when looking at the
broader market, as measured by the S&P 500, which is up just 7.0% YTD, CAT has shined. See Exhibit 4
below for the constituents and ratings on the stocks within our custom indexes.
Short-Form Thesis Is 2017 Annual Guidance A Risk? As detailed below, we believe CATs 2017 annual
revenue guidance, due out in 1.5-to-2 months, will serve as a downside catalyst. Furthermore, we believe all
three of CATs reportable segments are currently defined by: (a) CAPEX that is reverting lower to a new normal,
rather than the trough that many pundits are calling for (suggesting CAT should trade at a normal multiple to
2016 EPS as it represents normalized earnings, not a trough) Exhibit 1, (b) excess inventory (as we show in
exhibits below), and (c) fundamentals that remain in correction mode. Additionally, looking to CAT Financial, as
discussed below, owing to its exposure to a number of distressed companies, as well as aging receivables, and
what we see as a pending reversal in 2H15 reserves that we believe were released artificially, underlying costs,
we forebode, will prove an underappreciated headwind in out-quarters (2H15 reserves fell by $111mn versus
1H15 which we dont understand given credit trends were weakening at the time providing an estimated
$0.13/share benefit to CATs 2015 EPS we believe this benefit is slated to reverse in 2H16, as credit trends
are not in CATs favor at present, and havent been for some time now).
Be that as it may, as detailed below, in response to all of this, CAT appears to have resorted to accounting
chicanery in the form of changes to pension accounting (that appear set to materially benefit future
reported non-GAAP EPS), adjustments to the way segments are reported (in its favor), and aggressive
restructuring allowances i.e., it appears numbers are currently being goosed. Yet, admittedly, we
acknowledge that shorting industrial names that appear to be manufacturing numbers is always a risk when
CAT reported C2Q16 figures 7/26/16, it upped its expected 2016 restructuring charges to $700mn (which
allows the company to take a lot of costs out of non-GAAP EPS, painting a picture of EPS that may be far
above reality) from $500mn previously, and $400mn when C4Q15 figures were reported 1/28/16. That said,
when considering: (a) despite the fact that through the 1980s CAT embarked upon a massive restructuring
cycle aimed at building nonunion facilities in the US and abroad, outside of 1987, the company underperformed
the market essentially the entire decade (Exhibit 2), and (b) we believe it will become increasingly clear
through 2H16 and C1Q17 that the companys earnings power is less than $3.00/share annually looking forward
(i.e., 2016/17 earnings are a new normal, not a cycle bottom), we believe a swift revaluation lower in CATs
shares is likely in 2H16/C1Q17, similar to what happened to JOYs shares in 2015 (when many said JOY
couldnt fall) 20x sub-$3.00/share EPS means a stock headed for the sub-$60/share level. Finally,
notwithstanding all the issues highlighted above, a number of investors continue to use CATs high dividend
payout ratio (85% in 2015) as an impetus to own the shares. Yet, with our work suggesting, even on its
adjusted numbers (Exhibits 30-31), CAT will battle to earn its 2015 dividend in 2016, falling significantly
below the 2015 dividend in 2017 adjusted earnings, we believe a sizeable cut to CATs dividend is fated.
Caveat emptor.

Axiomcapital.com

DO NOT FORWARD (please help us protect your edge)

Page 2 of 28

Caterpillar, Incorporated
September 7, 2016

Exhibit 1: S&P 500 Sector CAPEX as a % of Total S&P 500 CAPEX

Polysilicon 45%

Ingot/Wafer

>40 play ers

Cells

~100
play ers

~50 pla yers

Module ~ 400

System > 5,000

play ers

pla yers

40%
35%
30%
25%
20%
15%
10%

5%

2014

2012

2010

2008

2006

2004

2002

2000

1998

1996

1994

1992

1990

0%

Energy

Industrials

Utilities

Materials

Telecom

Con. Disc.

Financials

Healthcare

Tech

Cons. Staples

Source: Bloomberg, Axiom Capital research.

Polysilicon

Ingot/Wafer

>40 play ers

~50 pla yers

Axiomcapital.com

Cells

~100
play ers

Module ~ 400

System > 5,000

play ers

pla yers

DO NOT FORWARD (please help us protect your edge)

Page 3 of 28

Caterpillar, Incorporated
September 7, 2016

This Space Left Intentionally Blank

Axiomcapital.com

DO NOT FORWARD (please help us protect your edge)

Page 4 of 28

Caterpillar, Incorporated
September 7, 2016

Exhibit 2: Despite Large Restructuring Charges Taken Throughout the 80s, CATs Shares Underperformed
Polysilicon

Ingot/Wafer

>40 play ers

~50 pla yers

Cells

~100
play ers

Module ~ 400

System > 5,000

play ers

pla yers

Source: Bloomberg, Axiom Capital research.

Valuation. We are introducing a year-end 2017 price target of $31/share (63% downside from Tuesdays
close), from $33/share previously, which we derive by applying an above-average 12x EV/EBITDA multiple
Polysilicon
Ingot/Wafer
Cells
100
Module 400
System 5,000
Exhibit
4ers to our new 2017
estimate ofplay$4.1bn
(Consensus play
$5.1bn),
adjusted for net
debt and
40 play
50 plaEBITDA
yers
ers
ers
pla yers
minority interest of $31.7bn and divided by 2017 year-end shares outstanding of 564.3mn (which assumes
24.3mn of share buybacks by year-end 2017). Our previous target price applied a 10.0x EV/EBITDA multiple to
our earlier 2017 EBITDA estimate of $5.01bn.
~

>

>

Is our valuation fair? Using a more traditional valuation approach (i.e., P/E), we estimate that CAT is grossly
overvalued.

Axiomcapital.com

DO NOT FORWARD (please help us protect your edge)

Page 5 of 28

Caterpillar, Incorporated
September 7, 2016

Price-to-Earnings: At a current stock price of $82.08, CAT is trading at 21.7x the next 12-month (NTM)
Consensus EPS estimate the highest NTM multiple since 21.7x in April 2010 (Exhibit 3). This ratio is even
higher, at 22.9x, when applied to the current Consensus EPS estimates of $3.58 for 2017, while on Caterpillars
own 2016 EPS guidance of $3.55, the stock is trading at 23.0x. These forward P/E multiples compare to the
companys 2-, 5-, and 8-year averages of 17.7x, 14.3x, and 15.3x, respectively.
Exhibit 3: Caterpillar's Historical NTM P/E Multiple
Polysilicon

35

>40 play ers

CAT's~Current
NTM
Cells
100

Ingot/Wafer

P/E:

21.7x ~ 400
Module

playHistorical
ers
2YR
Avg.:
5YR Historical Avg.:
8YR Historical Avg.:

~50 pla yers

30
25

System > 5,000

play ers
17.7x
14.3x
15.3x

pla yers

20
15

10
5

P/NTM EPS

Aug-16

Oct-15

Mar-16

May-15

Jul-14

Dec-14

Feb-14

Sep-13

Apr-13

Jun-12

Nov-12

Jan-12

Aug-11

Oct-10

Mar-11

May-10

Jul-09

Dec-09

Feb-09

Sep-08

Avg.

Note: Commercial bank assets are as-of February; these have not yet updated for March.
Source: Company data, Bloomberg, Axiom Capital Research.

Exhibit 4: Caterpillar's Historical NTM EV/EBITDA Multiple

Polysilicon
>40 play ers

Polysilicon

Ingot/Wafer

15x

>40 play ers

Cells

Module ~ 400

~100
play ers
~100
play ers

~50 pla yers

Ingot/Wafer

Cells

~50 pla yers

13x
11x
9x

System > 5,000

play ers
CAT's Current NTM EV/EBITDA:
8.6x
Module ~ 400
2YR Historical Avg.:
7.6x
play ers
5YR Historical Avg.:
6.9x
8YR Historical Avg.:
7.4x
Avg. Peak:
8.6x
Avg. Mid:
7.4x
Avg. Trough:
6.2x

pla yers

System > 5,000

pla yers

7x

5x

EV/NTM EBITDA

Aug-16

Mar-16

Oct-15

Dec-14

May-15

Jul-14

Feb-14

Sep-13

Apr-13

Jun-12

Nov-12

Jan-12

Aug-11

Mar-11

Oct-10

May-10

Dec-09

Jul-09

Feb-09

Sep-08

3x

Avg.

Note: Peak periods include 9/08, 5/09, 10/09, 4/10, 12/10, 1/12, 5/13, 5/15.
Note: Trough periods include 10/08, 7/09, 1/10, 8/10, 9/11, 6/12, 3/13, 1/15.
Source: Company data, Bloomberg, Axiom Capital Research.

Polysilicon

Ingot/Wafer

>40 play ers

~50 pla yers

Axiomcapital.com

Cells

~100
play ers

Module ~ 400

System > 5,000

play ers

pla yers

DO NOT FORWARD (please help us protect your edge)

Page 6 of 28

Caterpillar, Incorporated
September 7, 2016

Exhibit 5: Recent Stock Performance Axiom Capital Custom Indexes

Polysilicon

Ingot/Wafer

PEER
GROUP
>40 play
ers
~50 pla yers
Ticker
Company
MINING
RIO
Rio Tinto PLC
CLF
Cliffs Natural Resources Inc
FMG*
Fortescue Metals Group Ltd
BHP
BHP Billiton Ltd
VALE
Vale SA
MGX*
Mount Gibson Iron Ltd
GBG*
Gindalbie Metals Ltd
SID
Cia Siderurgica Nacional SA
CAP*
CAP SA
Subgroup: Value-Wgtd Avg
Covered Companies' Equal-Wgtd Avg
INDUSTRIAL EQUIPMENT
URI
United Rentals Inc
AHT*
Ashtead Group PLC
HTZ
Hertz Global Holdings Inc
HEES
H&E Equipment Services Inc
JOY
Joy Global Inc
CAT
Caterpillar Inc
FENR*
Fenner PLC
ASTE
Astec Industries Inc
042670 KS* Doosan Infracore Co Ltd
ATCOA*
Atlas Copco AB
SAND*
Sandvik AB
6301*
Komatsu Ltd
000528*
Guangxi Liugong Machinery Co.
600031*
Sany Heavy Industry Co Ltd
RR*
Rolls-Royce Holdings PLC
CMI
Cummins Inc
SIE*
Siemens AG
DE
Deere & Co
Subgroup: Value-Wgtd Avg
Covered Companies' Equal-Wgtd Avg
STEEL MILLS
X
United States Steel Corp
AKS
AK Steel Holding Corp
MT
ArcelorMittal
CMC
Commercial Metals Co
NUE
Nucor Corp
STLD
Steel Dynamics Inc
RS
Reliance Steel & Aluminum Co
WOR
Worthington Industries Inc
Subgroup: Value-Wgtd Avg
Covered Companies' Equal-Wgtd Avg
S&P 500 Index**

Share
Price
9/6/2016

Market
~100
Value
play ers
($MM)

Cells

Performance (%)

Axiom
Rating

Module ~ 400

System > 5,000

play ers

pla yers

1Day

1Mo

3Mo

YTD

6Mo

1YR

5.9%
16.1%
57.1%
8.3%
17.2%
50.0%
-5.6%
36.0%
51.2%
13.0%
26.4%

8.4%
269.0%
176.5%
22.7%
73.9%
66.7%
-19.0%
198.2%
108.5%
42.2%
151.3%

$ 31.58
$ 5.83
$ 3.97
$ 31.60
$ 5.72
$ 0.23
$ 0.01
$ 2.91
$ 5.39

$59,232
$1,331
$12,355
$79,007
$28,112
$252
$20
$4,038
$805

Hold
Sell
Sell
NC
NC
NC
NC
NC
NC

1.4%
1.7%
3.0%
3.2%
2.1%
0.0%
0.0%
0.0%
0.8%
2.4%
2.1%

-3.5%
-28.1%
13.38%
1.9%
-5.0%
3.4%
-10.5%
-15.9%
13.9%
-0.7%
-6.1%

4.2%
101.7%
67.9%
14.2%
30.6%
50.0%
-5.6%
47.7%
92.0%
18.8%
57.9%

-7.7%
51.0%
168.6%
-6.4%
20.9%
76.5%
-37.0%
196.9%
107.8%
14.5%
70.6%

$81.96
$1,688.49
$49.55
$15.85
$27.28
$82.08
$215.09
$59.23
$7.76
$29.26
$11.02
$22.18
$1.05
$0.82
$1,038.86
$116.94
$121.35
$84.47

$7,062
$8,465
$4,211
$562
$2,678
$47,954
$417
$1,365
$1,609
$34,850
$13,819
$21,561
$1,183
$6,205
$19,102
$19,721
$103,145
$26,559

Sell
NC
NC
NC
Sell
Sell
NC
NC
NC
NC
NC
NC
NC
NC
NC
NC
NC
NC

0.0%
-1.1%
-0.1%
-0.5%
0.1%
0.5%
-1.7%
0.6%
-1.0%
0.3%
-0.2%
-0.6%
1.4%
2.6%
-1.1%
-7.3%
0.0%
0.5%
-0.4%
0.2%

3.2% 11.3% 13.0% 42.6%

5.1% 27.7% 12.4% 39.4%
6.0% 15.8% -12.4% 19.1%
-11.6% -21.7% -9.3%
3.0%
-0.7% 22.8% 116.3% 54.3%
-0.6%
7.4% 20.8% 12.7%
0.3% 10.9% 12.1% 12.7%
-1.5%
8.9% 45.5% 34.9%
6.1% 33.7% 80.8% 36.7%
3.7% 17.1% 19.0% 18.4%
2.8% 15.2% 26.1% 14.5%
13.4% 16.8% 13.8% 18.1%
6.4%
6.4% -15.2% 2.2%
2.8%
8.1% -17.2% -1.6%
2.0% 26.4% 36.0% 8.3%
-6.7%
0.6% 32.9% 14.4%
5.3% 12.8% 20.1% 20.2%
7.8%
-3.4% 10.8% -0.5%
3.7% 11.9% 20.4% 16.6%
0.6% 13.8% 50.0% 36.5%

24.0%
28.7%
-29.2%
-15.6%
46.4%
12.3%
-3.5%
56.9%
36.9%
21.1%
21.9%
14.9%
-12.7%
-15.0%
10.0%
-0.9%
25.4%
6.6%
16.7%
27.6%

$19.48
$4.69
$6.31
$15.61
$49.58
$24.97
$73.99
$43.97

$3,226
$1,117
$19,345
$1,789
$15,784
$6,087
$5,366
$2,775

Sell
NC
NC
NC
NC
NC
NC
NC

$2,186

$18,543,844

3.1%
7.8%
4.5%
0.7%
1.1%
2.7%
2.0%
1.6%
2.8%
3.1%
0.3%

-26.5%
-23.9%
-2.3%
-6.4%
-7.4%
-5.5%
-3.1%
1.6%
-6.0%
-26.5%
0.2%

29.3%
61.7%
14.7%
5.7%
19.0%
33.5%
32.5%
82.7%
24.6%
29.3%
13.8%

21.7%
0.4%
17.1%
-11.9%
-1.7%
-2.0%
-2.4%
11.0%
6.5%
21.7%
4.2%

144.1%
109.4%
96.3%
14.0%
23.0%
39.7%
27.8%
45.9%
60.5%
144.1%
7.0%

50.1%
25.4%
70.8%
-0.8%
15.4%
26.3%
15.7%
34.5%
38.6%
50.1%
9.3%

Note: Subgroup averages are weighted based on current market cap; stocks under our coverage are averaged using an equal-weighting.
Note: (*) For comparison, non-US share prices and market caps are converted to USD.
Note: (**) The benchmark S&P 500 market is based on free-floating shares.
Source: Company data, Bloomberg Consensus estimates, Axiom Capital Research.

Axiomcapital.com
Polysilicon

DO NOT FORWARD (please help us protect your edge)

Ingot/Wafer

Cells

~100

Module ~ 400

Page 7 of 28
System > 5,000

Caterpillar, Incorporated
September 7, 2016

Exhibit 6: CAT Equipment Company Backlog-to-Sales Analysis

Polysilicon
>40 play ers

$s billions
12/31/2002
12/31/2003
12/31/2004
12/31/2005
12/31/2006
12/31/2007
12/31/2008
12/31/2009
12/31/2010
12/31/2011
12/31/2012
12/31/2013
12/31/2014
12/31/2015

$ Amount of Backlog
Ingot/W
CAT
Expectsafer
to
50 pla yers
Defer~for
One Year
(i.e., by following 12/31)
$0.32
$0.32
$0.60
$1.70
$1.90
$2.50
$2.20
$2.50
$2.80
$4.00
$4.50
$3.00
$3.00
$4.00

$ Amount of Backlog
CAT Expects toCells ~100 CAT Full Year
Recognize in One Yearplay ersRev Guidance Midpoint
(i.e., by following 12/31)
as of January
$4.59
$20.2
$4.58
$25.5
$8.50
$34.4
$10.50
$40.0
$12.60
$42.6
$15.30
$48.3
$12.50
$40.0
$7.10
$38.1
$15.90
$50.5
$25.80
$70.0
$15.70
$64.0
$15.00
$56.0
$14.30
$50.0
$9.00
$42.0

$ Amount of Backlog
Module ~ 400 CAT Expects to
play ers

Total
Backlog
$4.9
$4.9
$9.1
$12.2
$14.5
$17.8
$14.7
$9.6
$18.7
$29.8
$20.2
$18.0
$17.3
$13.0

Recognize in One Year

as % of Rev Guidance
22.8%
18.0%
24.7%
26.2%
29.6%
31.7%
31.2%
18.7%
31.5%
36.9%
24.5%
26.8%
28.6%
21.4%

System
5,000
CAT>Full
Year
pla yers

Rev Guidance
Change y/y %
26.5%
34.9%
16.3%
6.4%
13.6%
-17.2%
-4.8%
32.7%
38.6%
-8.6%
-12.5%
-10.7%
-16.0%

Average

$2.38

$12.24

$44.4

$14.6

26.6%

Implied '17 Rev Guide - Assuming Avg.

$4.20

$7.60

$28.6

$11.8

26.6%

-29.0%

Implied '17 Rev Guide - Assuming Low-End

$4.20

$7.60

$36.2

$11.8

21.0%

-10.1%

Assumes average $ amount of backlog CAT expects to recognize in one year as % of revenue guidance 2002-2015.
Assumes slightly higher $ amount of backlog CAT expects as % of revenue vs. two prior low periods as the industry backdrop is currently deteriorating.
Note: 2016 revenue guidance currently $40.25bn.
Note: "Implied 2017" numbers assume CAT's June 30, 2016 reported backlog is unchanged through the end of the year (even though it's been coming down).
Note: 18.0% $ amount of backlog as % of full-year revenue guide in 2003 came as the US was exiting recession and a commodity super-cycle was gaining
steam.
Note: 18.7% $ amount of backlog as % of full-year revenue guide in 2009 came as China rolled out its $4tn stimulus targeted at infrastructure, ushering in the
next commodity super cycle; and we were exiting the great recession.
Note: Looking into 2017, where CAT's dealer sales are down 44 consecutive months, and accelerating downward, we see the optimism that defined 2003 and
2009 as unlikely.
Source: Company filings, Bloomberg Consensus estimates, Axiom Capital Research.

Polysilicon

Ingot/Wafer

>40 play ers

~50 pla yers

Cells

~100
play ers

Module ~ 400

System > 5,000

play ers

pla yers

This Space Left Intentionally Blank

Axiomcapital.com

DO NOT FORWARD (please help us protect your edge)

Page 8 of 28

Caterpillar, Incorporated
September 7, 2016

Long Form Thesis 2016/17 Guidance at Risk? When applying math, and analyzing CAT from a historical
perspective, we believe the next major catalyst will come in 2-3 months when the company provides annual
2017 revenue guidance. To wit, when looking at the ratio of CATs backlog expected to be shipped within 12
months at the end of each year over the 2002-2015 timeframe, and then dividing this figure by CATs annual
sales guidance as of the following January each year, on average, the backlog CAT expects to ship within
12 months is 26.6% of expected full-year revenue Exhibit 6. Thus, taking the $7.6bn of backlog CAT
reported in its C2Q16 10-Q, and assuming backlog does not fall in 2H16 even though CATs backlog has
experienced a steady decline since peaking in C1Q12, and fell -9.9% quarter-over-quarter (QoQ) in C2Q16
(Exhibit 32) then adjusting for 26.6%, one arrives at implied 2017 sales guidance of $28.6bn, or 27.7% below
the Street (Consensus $39.5bn). While our current 2016 revenue estimate of $36.8bn is considerably above the
implied number using the methodology described above, as shown in Exhibit 7 below, when considering: (a)
CATs dealer sales fell to the second lowest level since the global financial crisis (GFC) in July, and
have now declined a record 44 straight months, (b) weakness in dealer sales accelerated in July, and (c)
the year-over-year (YoY) change in CATs dealer sales since 2002 have displayed a strong correlation to the
YoY change in CATs consolidated company sales, we see the risk/reward to CAT missing our low-end 2017
revenue estimate as skewed to the downside.
Exhibit 7: YoY Change in CAT Dealers Sales vs. YoY Change in CAT Consolidated Revenues
Polysilicon
>40 play ers

65%

Ingot/Wafer
~50 pla yers

Cells

~100
play ers

Module ~ 400

System > 5,000

play ers

pla yers

45%
"Great Recession"
19 Months

25%

"Great Recovery"
44 Months... And Counting

5%
-15%
-35%

-55%
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Worldwide Dealer Sales

CAT Revenue

Note: CAT's dealer sales are reported as the y/y change in rolling 3-month average.
Source: Company filings, Axiom Capital research.

The Bull Thesis. More broadly speaking, the bull thesis on CAT, and the justification for its current 23.3x 2016
P/E Polysilicon
multiple, rests with the Ingot/W
idea that
we are nearing
a cyclical
bottom for Module
a high 400
quality industry leader
(implying
afer
Cells
100
System 5,000
play ers
yers also see CAT Financial
play ers
play ers
pla yersand thus
201640represents
trough EPS).50 pla
Bulls
as a minor contributor
to CATs earnings,
see its exposure to a number of distressed industries, aging receivables, and likely, imminent, reversal of 2H15
released reserves as non-risks (2H15 reserves fell by $111mn versus 1H15 which we dont understand given
credit trends were weakening at the time providing an estimated $0.13/share benefit to CATs 2015 EPS we
believe this benefit is slated to reverse in 2H16, as credit trends are not in CATs favor, which we discuss
below). Bulls also find the companys dividend attractive (i.e., the yield argument), and feel everyone is already
~

>

Axiomcapital.com

>

DO NOT FORWARD (please help us protect your edge)

Page 9 of 28

Caterpillar, Incorporated
September 7, 2016

negative, implying all the downside is priced in. Whats more, as displayed in Exhibit 8 below, CAT
management is more than happy to fan these views, particularly the idea that we are near a cyclical bottom.
Exhibit 8: CAT Believes a Cyclical Bottom needs to be getting pretty close
Polysilicon

Ingot/Wafer

>40 play ers

~50 pla yers

Cells

~100
play ers

Module ~ 400

System > 5,000

play ers

pla yers

Source: 3/17/16 industry conference transcript.

Yet, analyzing CATs 2015 EPS guidance originally provided in 2011, and the constant reiterations of this target
only to subsequently cut it over the years, we are perplexed as to why investors continue to put so much faith in
Polysilicon
Ingot/Wafer
Cells
100
Module 400
System 5,000
a management
team that has50shown
an uncanny knack
under-deliver
(Exhibit pla
9).
40 play ers
pla yers
play ersto over-promise and
play
ers
yers
~

>

>

Exhibit 9: CAT Cuts 2015E EPS by Over $12/shr Since 2011, Yet Gets Credit for a $0.10/shr Raise (which it missed)
Polysilicon

$18.00

CAT Reiterates 2015 EPS

Ingot/W
aferof $15-$20/shr
Guidance

"Leveraged by implementation of the

Conf. on 11/8/11

$16.00

Production System, Caterpillar's

~Cat
100
initiatives are positioning the company
play ers
to deliver management's target of
more than $15 of earnings by 2015" Robert F. McCarthy, 11/8/11

Cells

atyers
Robert W. Baird Indus.
~50 pla

>40 play ers

Module ~ 400

$120.00

play ers

System > 5,000

pla yers

$110.00
$100.00

$14.00

$90.00
CAT Cuts 2015 EPS
Guidance to $12-$18/shr
at Analyst Day Meeting
9/24/12

$12.00

$10.00

$8.00

$80.00
CAT Increases 2015 EPS
Estimate by 10c to $4.70$4.60/shr in C1Q15
earnings release 4/23/15 CAT missed this guidance

$70.00
$60.00

$6.00

$50.00

$4.00

$40.00

CAT CY2015 EPS Estimate (lhs)

CAT Share Price (rhs)

Source: Company filings, Axiom Capital research..

Our View/Bear Thesis. We believe the narrative around CAT being near trough earnings will be thoroughly
disproven
when the company:
(a) provides annualCells
2017
sales guidance,Module
but more
importantly System
(b) is forced
to
Polysilicon
Ingot/Wafer
100
400
5,000
40
play
ers
50
pla
yers
play
ers
play
ers
pla
yers
repeatedly cut numbers below Consensus through 2017. What gives us confidence? Qualitatively, we believe
~

>

Axiomcapital.com

>

DO NOT FORWARD (please help us protect your edge)

Page 10 of 28

Caterpillar, Incorporated
September 7, 2016

the sharp contraction in mining CAPEX experienced recently (Exhibit 10) is structural, rather than a temporary
dip. Stated differently, we believe mining CAPEX is reverting back to the long-term mean, suggesting the
mining equipment spending resurgence that the lions share of pundits are holding out for is never
coming (we are sorry to be the bearer of bad news). And, while we have heard the calls from many that CATs
stock never falls, similar to the sudden/drastic fall that befell JOY Globals (JOY; SELL) stock when investors
realized its problems were structural/static, when the market comes to this realization for CAT in C4Q16/2017,
we see a similar fate in the offing.
Quantitatively, the picture doesnt get any better. In what follows, we highlight, briefly, the headwinds facing
each one of CATs operating divisions, including Resource Industries (RI), Construction Industries (CI),
Energy & Transport (E&T), and last but certainly not least Caterpillar Financial.

Resource Industries (RI): As detailed in Exhibit 10 below, while the popular narrative centers on a
coming resurgence in RI CAPEX expenditures, we believe we are in the middle innings of a classic mean
reversion (i.e., lower capital expenditures across the RI complex are a new normal, rather than cyclebottoming). Further, as shown below, with excess RI equipment in the market, we see a one to two year
destocking period pushing both order rates and RI CAPEX spend temporarily below the historical norm.
Thus, when considering orders typically lead sales, we see storm clouds forming around CATs 2017/2018
revenue outlook. In fact, given 1H16 orders are running 18.1% below 1H15 orders, and keeping in mind
that, again, orders lead sales, 2017 sales appear to be indicating down roughly 18% versus 2016 (Exhibit
11). Furthermore, as it pertains to CATs RI division, yet a theme present in each of the companys
reportable segments, when looking at data from both CATused.com (Exhibit 12) and The Parker Bay
Company (Exhibit 13), excessive inventory appears to be a growing, and in many cases spiking, dilemma.
Consequently, as this picture begins to materialize, we expect investors, increasingly, to look at
CATs declining EPS in 2016 and 2017 as a new normal rather than a trough.

Exhibit 10: BEA Private Fixed Investment Mining Exploration Shafts

$180

Polysilicon

Ingot/Wafer

>40 play ers

Cells

~100
play ers

~50 pla yers

Module ~ 400

System > 5,000

play ers

pla yers

$160
$140

$s billions

$120
$100
$80
$60
$40
$20
$0
1958

1962

1967

1971

1976

1980

1985

1989

1994

1998

2003

2007

2012

2016

BEA Private Fixed Investment Mining Exploration Shafts & Wells SAAR

Source: Bureau of Economic Analysis, Bureau of Labor Statistics, Axiom Capital research..

Axiomcapital.com

DO NOT FORWARD (please help us protect your edge)

Page 11 of 28

Caterpillar, Incorporated
September 7, 2016

Exhibit 11: CAT: Total Implied Orders Annualized

Polysilicon

$100,000

>40 play ers

Ingot/Wafer
$s millions

Cells

~100
play ers

~50 pla yers

Module ~ 400

System > 5,000

play ers

pla yers

$90,000
$80,000
$70,000
$60,000
$50,000
$40,000
$30,000

$20,000
$10,000

C4Q07
C1Q08
C2Q08
C3Q08
C4Q08
C1Q09
C2Q09
C3Q09
C4Q09
C1Q10
C2Q10
C3Q10
C4Q10
C1Q11
C2Q11
C3Q11
C4Q11
C1Q12
C2Q12
C3Q12
C4Q12
C1Q13
C2Q13
C3Q13
C4Q13
C1Q14
C2Q14
C3Q14
C4Q14
C1Q15
C2Q15
C3Q15
C4Q15
C1Q16
C2Q16

$0

CAT: Total Implied Orders Annualized

Source: Company filings, Axiom Capital research..

Exhibit 12: CAT Used Off-Highway Trucks Listed For Sale

Polysilicon
Ingot/Wafer
(North America)
>40 play ers

631

Polysilicon
>40 play ers
Units

~50 pla yers

Ingot/Wafer
~50 pla yers

Exhibit 13: Off-Highway Mining Truck Population

Cells

~
100
45,031
play ers
Cells ~100
40,031
play ers

Units

Module ~ 400

System > 5,000

pla
yers41641 41953 41906
41444

play ers

Polysilicon

Module ~ 400

Ingot/Wafer

>40 play ers

play ers

~50 pla yers

35,031

System > 5,000

pla yers

35958

Cells

~100
play ers

32012

531

29686

30,031

27722

24812

25,031

431

40221

22293
20373

20,031
331

16677 16978
15811 16406

18344

15,031
231

10,031
5,031

131

31
31
May-12 Mar-13 Mar-14 Jun-15 Nov-15 Dec-15 Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16 Jul-16 Aug-16

Source: CATused.com, Axiom Capital research.

Source: The Parker Bay Company, Axiom Capital research.

Construction Industries (CI): Since peaking 5/31/15, Dodge non-residential construction starts, on a
last twelve-month basis (LTM), have been on a steady Polysilicon
decline lower (ExhibitIngot/W
14). In
fact, at $182bnCells
in 100
afer
Polysilicon
Ingot/Wafer
Cells
100
Module 400
System 5,000
40
play
ers
50
pla
yers
play
ers
40 play ersLTM Dodge non-residential
50 pla yers
play ers
play ers since 5/31/15, or pla
yers
June,
construction
starts were the lowest
immediately
preceding CATs 25.2% share-price correction lower (5/29/15-to-9/28/15) due, partially, to fears
surrounding weakness in US non-residential markets. And, with CATs LTM consolidated EBITDA virtually
mirroring Dodge non-residential construction data during the last major downturn (i.e., the GFC), and nonresidential construction far from trough, we see prolonged weakness in CATs construction EBITDA.
~

>

Axiomcapital.com

>

DO NOT FORWARD (please help us protect your edge)

>

Page 12 of 28

Caterpillar, Incorporated
September 7, 2016

Exhibit 14: LTM Dodge Non-Residential Construction Starts versus CAT's Construction Industries LTM EBITDA
Polysilicon
>40 play ers

$220

Ingot/Wafer
~50 pla yers

$210
$200
$190

~100
The last structuralCells
decline
in
play ers
non-residental construction
corresponded with CAT's
EBITDA turnig negative... will
this time be different?

$14,000

Module ~ 400

System > 5,000

play ers

pla yers

$12,000

$10,000

$180

$8,000

$170
$6,000

$160
$150

$4,000

$140
$2,000

$130

$120
Nov-08

$0
Jul-09

Mar-10 Nov-10

Jul-11

Mar-12 Nov-12

Jul-13

Mar-14 Nov-14

Dodge LTM Avg. Non-Resi Construction Starts - Left Axis ($bn)

Jul-15

Mar-16

URI LTM EBITDA - Right Axis ($mn)

Note: Shaded areas represent recessions, as defined by the U.S. National Bureau of Economic Research.
Source: Dodge Data & Analytics, company data, Axiom Capital research.

Keeping with the theme of CATs CI segment, we note that when looking at data from CATused.com, over
time,
for both used excavators
(Exhibit 15) and
backhoe
loaders (Exhibit
16), a somewhatSystem
striking
trend
Polysilicon
Ingot/Wafer
Cells
100
Module 400
5,000
40
play
ers
50
pla
yers
play
ers
play
ers
pla
yers
emerges. That is, while on a steady slope higher for some time now, the availability of excavator and
backhoe equipment seems to have spiked higher more recently, similar to the dynamic currently defining
CATs RI segment. Thus, in addition to weak underlying demand, defined by weakening Dodge nonresidential construction starts, excess supply seems to be a problem as well. At risk of stating the obvious,
this portends additional margin pressure on the horizon.
~

>

>

Exhibit 16: CAT Used Backhoe Loaders Listed For Sale

(NORTH AMERICA)

Exhibit 15: CAT Used Excavators Listed For Sale

(NORTH AMERICA)
5,031

Polysilicon

Polysilicon
Cells 1,431
~100
Units

Ingot/Wafer

Units>40 play ers

~50 pla yers

play ers

4,531

>40 play ers

Module ~ 400

Ingot/Wafer

System > 5,000

play ers

~50 pla yers

pla yers

Cells

~100
play ers

1,231

4,031

1,031
3,531
3,031

831

2,531

631
2,031

431

1,531
1,031

231
531

31

31
May-13

Apr-14

Jun-15

Dec-15

Jan-16

Feb-16

Mar-16

Apr-16

May-16

Jun-16

Jul-16

Polysilicon

Ingot/Wafer

Apr-14

Jun-15

Dec-15

Jan-16

Feb-16

Cells

~100

Polysilicon

Module ~ 400

play ers
play ers
play ers
DO NOT FORWARD (please
help>40us
protect your
edge)

~50 pla yers

Mar-16

Apr-16

May-16

Jun-16

Jul-16

Aug-16

Note: Looks at availability of used equipment on date specified.

Source: CATused.com, Axiom Capital research.

Note: Looks at availability of used equipment on date specified.

Source: CATused.com, Axiom Capital research.

>40 play ers

Axiomcapital.com

May-13

Aug-16

Ingot/Wafer
~50 pla yers

System > 5,000

Cells

~100

pla yers
Page
13 of 28play ers

Caterpillar, Incorporated
September 7, 2016

Energy & Transportation (E&T): As detailed in Exhibit 17 below, and similar to what appears to be a
mean reversion in CATs RI CAPEX currently underway, the companys E&T CAPEX seems to be
returning to a more normalized level. Yet, unlike RI CAPEX, which seems to nearing steady-state, E&T
CAPEX seems to still have quite a bit of downside left. Thus, with hopes that oil prices were reaching
escape velocity now largely in the rear-view mirror, it would seem to reason that CAPEX spend in CATs
E&T segment could still be ways away from reaching a state of stability. Stated differently, barring an
inflection higher in oil prices over the near-term, we see the issues currently plaguing CATs E&T segment
actually intensifying over the near-to-intermediate term.

Exhibit 17: BEA Real Private Fixed Investment Petroleum & Nat. Gas Quantity Index
$300

Polysilicon
>40 play ers

Ingot/Wafer
~50 pla yers

Cells

~100
play ers

Module ~ 400

System > 5,000

play ers

pla yers

$250

$s billions

$200

$150

$100

$50

$0

Source: Bureau of Economic Analysis, Axiom Capital research.

Keeping on the theme of CATs E&T segment, moving to the transportation side, the picture remains
challenged. That is, as displayed in Exhibits 18-19 below, when looking at reported locomotives in
Polysilicon
Ingot/Wafer
Cells
100
Module 400
System 5,000
storage
(NSC; NC) and
Union
Pacific (UNP;
NC),
inventory is currently
40 play ers for both Norfolk Southern
50 pla yers
play ers
play
ers
pla yerssitting at
levels not seen since the GFC. In our view, in addition to the pressure being exerted on CATs E&T margins
as a result of deteriorating end-market demand (evidenced by CAPEX that appears to be far from reaching
a normalized level), the risks associated with excess inventory are also present. Overall, this does not bode
well for the near-to-intermediate-term outlook for CATs E&T segment.
~

>

Axiomcapital.com

>

DO NOT FORWARD (please help us protect your edge)

Page 14 of 28

Caterpillar, Incorporated
September 7, 2016

Exhibit 18: Norfolk Southern Locomotives in Storage

Exhibit 19: Union Pacific Locomotives in Storage

2,031

500

Units

450

Polysilicon

Ingot/Wafer

>40 play ers

~50 pla yers

Cells 1,831
~100
play ers

Units
Polysilicon

Module ~ 400

Ingot/Wafer

System > 5,000

>40 play ers

play ers

~50 pla yers

pla yers

Cells

~100
play ers

1,631
400

1,431
350

1,231
300

1,031
250

831
200

631
150

431

100

231

50

31

0
Aug-09

Dec-11

Oct-12

Jan-13

Oct-13

Dec-14

Jun-15

Dec-15

Mar-16

Jul-16

Note: Norfolk has approximately 415 active locomotives currently.

Source: Company filings, Axiom Capital research.

Note: Union Pacific has approximately 6,590 active locomotives currently.

Source: Company filings, Axiom Capital research.

Caterpillar Financial (CAT Fin): First focusing on CAT Fins exposure to distressed companies, as
detailed
in Exhibit 20 below,
we provide the progression,
as
per Haynes
& Boone,Ingot/W
of cumulative
bankruptcy
Polysilicon
Ingot/Wafer
Cells
100
Module 400
System 5,000
Polysilicon
afer
Cells
100
40 play ers
50 pla yers
play ers
play ers
pla yers
40 play ers
50 pla yers
play ers
filings for North American energy and procurement (E&P) companies 2015-to-2016 if you would like
more granular detail, please see this link, and specifically pages 6-8, for a comprehensive list of the
companies that have filed.
~

>

>

>

Exhibit 20: Haynes & Boone Oil Patch Bankruptcy Monitor

Polysilicon

Ingot/Wafer

>40 play ers

~50 pla yers

Cells

~100
play ers

Module ~ 400

System > 5,000

play ers

pla yers

Source: Haynes and Boone, LLP.

Polysilicon

Ingot/Wafer

>40 play ers

~50 pla yers

Axiomcapital.com

Cells

~100
play ers

Module ~ 400

System > 5,000

play ers

pla yers

DO NOT FORWARD (please help us protect your edge)

Page 15 of 28

Caterpillar, Incorporated
September 7, 2016

Yet, keeping with the theme of CAT Fins exposure to distressed companies, as detailed in Exhibit 21
below, when looking at the major accounts at CAT Fin as of 8/2016 CAT stopped disclosing this list
shortly after we first published it 10/21/15 since we last updated this list 6/2015, 58 out of the 199 major
customers at CAT Fin have a weaker default grade (48.7%), while 35 have a similar default grade (29.4%),
and just 26 have a better default grade (21.8%). In fact, since we last updated this analysis, six of CAT Fins
major portfolio companies have gone into bankruptcy (Patriot Coal [PCXCQ; NC], Peabody Energy [BTU;
NC], Atna [ATNAQ; NC], Armstrong Coal [0732570D; NC], Arch Coal [ACI; NC], and Alpha Natural
Resources [ANR; NC]).

This Space Left Intentionally Blank

Axiomcapital.com

DO NOT FORWARD (please help us protect your edge)

Page 16 of 28

Caterpillar, Incorporated
September 7, 2016

Exhibit 21: CAT Financial Major Account List June 15-to-Aug. 16 48.7% of Major Accounts Showed Decline in Default Grade
CAT Financial Major Accounts List c. 4/2014

Polysilicon

Name

>40 play ers

African Barrick Gold

African Rainbow Minerals
Agnico Eagle
Alcoa
Allied Nevada/Hycroft
Alpha Natural Resources/Massey
Alumina
Anglo American
AngloGold Ashanti
Antofagasta
ArcelorMittal
Arch Coal
Areva
Armstrong Coal
Asarco (Grupo Mexico)
Atna
AuRico Gold
Ausdrill
Averig Moolmans
Barrick
Basil Read
BHP
Bollden
Brigus Gold/Primero Mining
Buenaventura
Cameco
Catalyst Resources Group
Cedar Lake Mining/MS&R Equip
Cemex
Centennial Coal/Banpu
Chinalco Mining
Chinalco Yunnan Copper Resources
Cliffs
Cline Group/Foresight
CONSOL Energy
Crocodile Gold
CSN
Degerstrom
Downer
Drummond Gold
Emeco Holdings
Eqstra
Eramet
ESSAR
Evraz
Exxaro
Ferrous
First Quantum Minerals
Fortescue Metals Group
Fresnillo
Frisco
Glencore
Globe Specialty Metals/Alden
GoldCorp
Golden Star
Goldfields
Harmony Gold
Hecla
Heidelberg Cement AG
Holcim

Owner/Ticker
ACA.LN
ARI.SJ
AEM.CN
AA
ANVGQ
ANRZ
AWC.AU
AAL.LN
ANG.SJ
ANTO.LN
MT.NA
ACI
AREVA.FP
ARMS
GMEXICOB.MM
ATN.CN
AUQ.CN
ASL.AU
AEG.SJ
ABX
BSR.SJ
BLT.LN
BOL.SS
P.CN
BUENAVC1.PE
CCO.CN
CATA
private
CX
BANPU.TB
3668.HK
CYU.AU
CLF
FELP
CNX
CRK.CN
CSNA3.BZ
private
DOW.AU
DGO.AU
EHL.AU
EQS.SJ
ERA.FP
ESOIL.IN
EVR.LN
EXX.SJ
private
FM.CN
FMG.AU
FRES.LN
MFRISCOA.MM
GLEN.LN
GSM
G.CN
GSS
IGS.AU
HAR.SJ
HL
HEI.GR
LHN.VX

CAT Financial Major Accounts List c. 4/2014

Ingot/Wafer

Cells

Default
Default
Adj Net Income
~100
1-Year Return as Default Grade
Default Grade:
Market Cap in
Grade in June Grade in
(T12M) in mlns
of 6/15/15
in June 2012 ~50 pla yers
Worse or Better?
mlns USD
play ers
2015
August 2016
USD
38%
-48%
7%
-16%
-96%
-89%
13%
-26%
-35%
-1%
-12%
-89%
-49%
17%
5%
-15%
-42%
-68%
-31%
-34%
-20%
77%
-33%
-11%
-71%
-25%
-9%
12%
-22%
-62%
-27%
-45%
36%
-33%
21%
0%
-57%
-51%
-26%
33%
62%
-34%
-20%
-41%
-12%
-51%
-11%
-7%
-23%
-43%
300%
-48%
-5%
13%
-12%

IG5
IG6
IG8
HY1
IG6
HY4
IG9
IG8
IG7
IG8
HY2
HY3
HY2
IG10
IG7
IG10
IG9
IG8
IG4
IG8
IG9
IG7
IG9
IG10
IG5
IG7
DS5
IG7
HY2
IG9

IG7
IG8
IG8
IG9
Default
HY6
IG7
IG9
IG10
IG7
IG10
HY6
IG10
HY4
IG6
HY4
IG10
HY3
HY4
IG10
HY3
IG6
IG7
IG10
IG9
IG7
DS4
IG10
IG9
IG9
HY2
HY5
HY4
IG9
IG10
IG10
HY2
IG10
IG9
DS4
HY4
HY1
IG10
IG10
IG10
IG6
HY1
HY1
HY1
IG6
IG9
IG8
IG6
IG8
HY3
DS5
IG9
IG10
IG8
IG7

IG10
IG10
HY1
IG10
HY1
IG10
HY1
HY5
IG8
IG10
IG9
HY3
HY1
IG6
HY1
IG7
IG10
IG7
IG9
IG8
IG5
IG8
HY2
IG9
IG6
IG8
HY1
IG9

IG7
IG9
IG7
HY1
Default
IG6
HY2
IG9
IG10
HY1
Default
HY4
Default
IG8
Default
HY5
HY1
HY4
IG9
HY4
IG9
IG8
IG10
HY1
IG9
DS4
IG10
HY1
HY1
HY1
DS2
HY2
HY5
HY1
IG5
HY2
IG10
IG9
HY5
HY3
HY2
HY3
HY4
HY1
IG9
HY1
HY2
HY1
IG6
IG9
HY1
IG10
IG9
HY1
DS4
IG9
IG10
IG9
IG7

(218)
(133)
33
(305)
(890)
(707)
(26)
(3,422)
110
(10)
(6,701)
(3,014)
(2,167)
NA
1,267
(29)
(539)
42
(7)
(2,831)
12
(6,385)
263
(136)
(209)
(55)
NA
NA
348
(41)
(72)
(6)
71
(126)
(418)
39
159
NA
132
(1)
(164)
(81)
(857)
250
(667)
29
NA
(406)
984
161
(240)
(4,657)
(58)
(4,461)
(13)
(8)
(304)
(49)
997
(1,786)

2,720
1,362
12,400
13,377
NA
NA
3,181
14,272
7,070
6,671
19,030
NA
2,564
NA
19,664
NA
NA
390
165
21,978
24
78,741
5,913
314
3,748
3,701
NA
NA
12,002
1,822
1,585
2
1,313
575
4,272
NA
3,997
NA
1,645
1
25
78
955
5,744
2,529
2,036
NA
5,445
12,351
16,887
2,053
35,324
1,447
14,000
247
NA
1,733
2,377
18,310
32,418

Name

Iamgold
Idemitsu
Imperial Oil Resources/Exxon
IOC/QIT/QNSL (Rio Tinto)
James River Coal
Kazakhmys
KGHM International
Kinross Gold Corp
Kinsgate
Kumba Iron Ore
Lafarge
Lanco
Lonmin
MacMahon Holdings
Magnitogorsk
Mechel
Mercator Minerals
Molycorp
Montana Exploration Corp
Mt. Gibson Iron Ore
New Gold Corp
New World Resources
Newcrest Mining
Newmont Mining
Norilsk
North American Construction
Northam
Northern Star Resources
NRW Holdings
Nyrstar NV
OZ Minerals
Patriot Coal
Peabody Energy
Polymetallic Mining
Polyus Gold
Prairie Mines
Randgold
Resolute Mining
Rio Tinto
Rusal
Sentual
Severstal
Silver Standard
St. Barbara
Suncor Energy
Tata
Teck
Teco
Terramin
Thompson Creek
Total SA
VALE
Vedanta
Walter Energy
Watpac
Whitehaven
Yamana
Mirabela Nickel
Discovery Metals

Module
~ 400
1-Year Return
as Default Grade

Owner/Ticker

of 6/15/15
play
ers

IMG.CN
5019.JP
IMO.CN
RIO.LN
JRCCQ
KAZ.LN
KGH.PW
KGC
KCN.AU
KIO.SJ
LG.FP
LANCI.IN
LMI.LN
MAH.AU
MAGN.RM
MTLR.RM
ML.CN
MCPIQ
MTZ.CN
MGX.AU
NGD
NWR.LN
NCM.AU
NEM
GMKN.RM
private
NHM.SJ
NST.AU
NWH.AU
NYR.BB
OZL.AU
PATCA
BTU
2133.HK
PGIL.LN
PDZ.AU
RNG.SJ
RSG.AU
RIO.AU
486.HK
SNU.SJ
CHMF.RM
SSO.CN
SBM.AU
SU.CN
TATA.IN
TCK/B.CN
TE
TZN.AU
TCM.CN
FP.FP
VALE5.BZ
VED.LN
WLT
WTP.AU
WHC.AU
YRI.CN
MBN.AU
DML.AU

-34%
21%
-14%
-5%
-96%
-11%
2%
-43%
113%
-45%
-7%
-65%
-48%
-55%
127%
36%
Delisted
-85%
-11%
-67%
-48%
-94%
28%
4%
70%
-11%
71%
-79%
94%
13%
-85%
72%
5%
-44%
-7%
-52%
1%
13%
-4%
150%
-5%
229%
-24%
-44%
-39%
6%
241%
-60%
-12%
-28%
-45%
-95%
4%
-2%
-55%
Suspended

in June 2012
IG5
IG10
IG6
IG9
HY5
IG10
IG7
IG8
IG10
IG5
HY1
HY5
IG9
IG9
HY1
HY3
HY2
IG9
DS1
IG9
IG7
HY2
IG6
IG7
IG7
HY6
IG10
IG7
IG8
HY2
IG4
HY3
HY1
IG9
IG3
HY1
IG10
IG6
IG8
IG9
IG10
HY1
IG10
IG9
IG8
HY1
IG9
IG7
HY4
IG10
IG8
IG7
HY3
HY2
IG10
IG7
IG7
HY5
HY1

System

Default
Default
Adj
Income
>Net
5,000
Default Grade:
Market Cap in
Grade in June Grade in
(T12M) in mlns
Worse or Better?
mlns USD
pla yersUSD
2015
August 2016
HY1
IG8
IG6
IG6
Default
IG10
IG7
IG10
HY1
IG9
IG9
HY6
HY1
HY2
IG10
HY4
DS1
Default
HY5
HY3
IG10
HY5
IG8
IG8
IG8
HY6
IG6
IG8
HY4
IG9
IG5
DS1
HY4
HY1
IG5
HY2
IG6
HY1
IG6
IG10
HY4
IG8
IG10
HY2
IG7
HY1
IG10
IG7
HY3
HY3
IG10
IG10
HY2
Default
IG9
IG10
IG10
Default
Default

HY1
IG10
IG7
IG6

(719)
(249)
226
41
(92)
74
(1,527)
(934)
(192)
65
(486)
(41)
(1,586)
1
439
NA
(1)
(872)
(1)
63
(149)
(248)
332
40
1,561
NA
(35)
110
16
(470)
79
(426)
(1,223)
(24)
1,033
(5)
0
132
41
(60)
(26)
681
(111)
123
(2,167)
(466)
(1,884)
183
(3)
(41)
3,147
(8,128)
(1,837)
(2,822)
(16)
15
(1,884)
NA
15

HY5
IG9
IG10
HY1
IG9
IG10
HY6
IG10
HY1
IG8
HY5
HY5
HY6
IG10
IG10
DS2
IG8
IG8
IG8
HY6
IG5
IG6
HY3
HY4
IG6
Default
Default
HY2
IG8
HY1
IG6
IG9
IG8
IG10
HY1
IG7
IG9
IG10
IG8
HY1
HY1
IG10
HY2
HY4
IG8
HY1
HY2
IG8
IG10
IG10

1,923
3,021
26,931
58,566
NA
1,106
3,929
5,651
NA
3,202
NA
205
776
102
5,454
469
25
8
8
252
2,857
NA
13,285
21,754
24,133
NA
1,818
1,925
114
720
1,465
NA
NA
55
NA
19
13
1,026
58,566
5,642
13
10,134
1,577
1,118
45,821
5,650
10,121
NA
145
121
123,719
27,089
1,807
NA
123
1,708
4,568
NA
NA

Note: CAT stopped disclosing this list shortly after we first published it 10/21/15.
Source: Company filings, http://cafinance.cat.com/cda/files/3267621/7/MajorAccountsContactList040214.pdf.

In addition to the above, when looking at the amount of CAT Fin receivables 91+ days past due, we note
that an all-time high was set in C2Q16 (Exhibit 22). Further to this point, as detailed in Exhibit 23 below,
Polysilicon
Ingot/Wafer
Cells
100
Module 400
System 5,000
with
the
still accruing spiking
hard
to see
40 play
ers amount of receivables
50 pla yers 91+ days past due
playand
ers
play ers in C2Q16, we find itpla
yers
a scenario where CAT Fins costs do not see a sharp mover higher over the near-term. This is among the
pillars of our thesis on CAT Fin (i.e., that CAT Fin will prove a much bigger drag on earnings than market
prognosticators are currently modeling), and among the reasons we maintain a negative bias on the parent
company at present.
~

>

Axiomcapital.com

>

DO NOT FORWARD (please help us protect your edge)

Page 17 of 28

Caterpillar, Incorporated
September 7, 2016

Exhibit 22: CAT Financial: 91+ Days Past Due Total Finance
Receivables
Polysilicon
$700.0

Ingot/Wafer

>40 play ers

$s millions

~50 pla yers

Exhibit 23: CAT Financial: 91+ Days Past Due and Still Accruing
$120.0

Cells

~100

2.60%
play ers

$s millions
Polysilicon
>40 play ers

0.50%

Module ~ 400

Ingot/Wafer

System > 5,000

play ers

~50 pla yers

pla yers

$100.0

2.20%

$500.0

~100
play ers

0.40%

2.40%

$600.0

Cells
0.45%

0.35%

$80.0

0.30%
2.00%

$60.0

$400.0

0.25%

1.80%
$300.0
1.60%

$200.0

1.40%

$100.0

0.20%
$40.0

0.15%

0.10%

$20.0

0.05%

1.20%

$0.0

$0.0

1.00%

91+ Days Past Due (lhs)

0.00%

91+ Days Past Due & Still Accruing

% of Total Finance Recievables (rhs)

Source: Company filings, Axiom Capital research.

% of Total Finance Recievables (rhs)

Source: Company filings, Axiom Capital research.

Yet, theres more. That is, looking back to 2H15, as a number of the companies underpinning CATs
financial arm were seeing a deterioration in credit quality (Exhibit 21), CAT actually released reserves to
Polysilicon
Ingot/Wafer
Cells
100
Module 400
System 5,000
Polysilicon
Ingot/Wafer
Cells
100
the
tune
a 30% play
taxersrate, added
$0.13/share
40 play
ers of $111mn (i.e., 2H15
50 pla yersversus 1H15), which
play erswhen using
pla yers to 2015
40 play ers
50 pla yers
play ers
EPS. Thus, in what should have been a drain on EPS, when looking purely at the credit quality of the
companies in CAT Fins portfolio, CAT actually reaped a sizeable EPS benefit (Exhibit 24). Yet, with the
majority of CAT Fins customers experiencing crumbling credit quality at present, exacerbated by the fact
that six more of the companys largest customers are officially in default since the last time we updated the
analysis captured in Exhibit 21, as CAT rebuilds its reserves this year, and likely next, we see the benefits
to EPS that defined 2015 reversing (a 2H16 and 2017 headwind).
~

>

>

>

Exhibit 24: CAT Financial: Allowance for Credit Losses & Total Finance Receivables
$430

Polysilicon
>40 play ers

Ingot/Wafer
~50 pla yers

Cells

~100
play ers

Module ~ 400

1.60%

play ers

$420

System > 5,000

pla yers

1.55%

$410
1.50%

$s millions

$400
1.45%

$390
$380

1.40%

$370

1.35%

$360
1.30%

$350
1.25%

$340
$330

1.20%

Allowance for Loan Losses (lhs)

Allowance for Credit Losses Total Finance Recievables (rhs)

Source: Company filings, Axiom Capital research.

Axiomcapital.com

DO NOT FORWARD (please help us protect your edge)

Page 18 of 28

Caterpillar, Incorporated
September 7, 2016

CATs Response to Industry Headwinds, Based on Our Work, Has Been to Manufacture Fantasy
Numbers. CAT managements short-term compensation payout trigger is $3.50/share in non-GAAP EPS in
2016 (the same as 2014 and 2015). Thus, with a focus on EPS, rather than return on assets (ROA), it seems
management has outsized incentive to manage earnings in order to get paid. And, based on this article by
Steve Tarter, at CATs most recent annual meeting in Kansas, a scene of a public uprising emerged when 33%
of stockholder votes opposed the companys executive compensation program, an unusually stinging rebuke
for such a poll, according to the Wall Street Journal. Yet, it is this focus on EPS that may be pushing CAT to
resort to accounting chicanery in order to hit executive compensation targets.
With the above as a backdrop, in what follows, we highlight the three key areas where we believe CAT is
employing management to boost non-GAAP EPS to levels that are not indicative of its fundamental operating
backdrop, including Changes to Pension Accounting (that appear set to materially benefit future reported
non-GAAP EPS), Adjustments to the way Segments are Reported (in its favor), and Aggressive
Restructuring Allowances.

Changes to Pension Accounting: As displayed in Exhibit 25 below, when parsing through all the
accounting rhetoric, after cutting its full-year EPS guidance a number of times throughout 2015, in an
impromptu move, CAT decided to change the way it discounts its future pension and OPEB service and
interest costs. More specifically, instead of using a single weighted-average discount rate, beginning in
2016 CAT is now using the entire yield curve. More simply stated, using the entire yield curve, versus one
particular rate, allows CAT to assume a higher discount rate, which in terms of the time value of money
means a lower current value/cost obligation.

Exhibit 25: CAT Explanation for 1/1/16 Favorable Non-GAAP Change in Pension Expense Accounting

At December 31, 2015, we changed our method for calculating the service and interest cost components of net periodic benefit cost.
Polysilicon
Ingot/Wafer
Cells ~100
Module ~ 400
System > 5,000
Historically,
these components were
determined
utilizing a single
weighted-average discount
used to
>40 play ers
~50 pla
yers
play ers
play ersrate based on a yield curve
pla yers
measure the benefit obligation at the beginning of the period. Beginning in 2016, we have elected to utilize a full yield curve approach
in the estimation of the service and interest costs by applying the specific spot rates along the yield curve used in the determination of
the benefit obligation to the relevant projected cash flows. We have made this change to provide a more precise measurement of
service and interest costs by improving the correlation between the projected cash flows to the corresponding spot rates along the yield
curve. Compared to the method used in 2015, we expect this change to result in lower pension and other postretirement benefit expense
of approximately $180 million in 2016 before considering the change in accounting principle discussed in the paragraph below. This
change will have no impact on pension and other postretirement benefit liabilities and will be accounted for prospectively as a change in
accounting estimate.
Source: CAT 2015 10-K, Axiom Capital research.

So what are the benefits of this impromptu adjustment to pension accounting treatment? Well, as displayed
in Exhibit 26 below, when looking at just 1H15, the recast pension cost compared to what was originally
Polysilicon
Ingot/Wafer
Cells
100
Module 400
5,000
reported
represents a benefit
to CAT of $378mn
(yes,
you heard that
right). Furthermore,System
aspla yers
outlined
in
40 play ers
50 pla yers
play ers
play ers
Exhibits 27-28 below, while CATs 2016 EPS outlook includes the benefits associated with this change, it
excludes any impact from mark-to-market gains or losses resulting from pension and OPEB plan
remeasurements. Stated differently, CAT is explicitly stating that it is excluding any risk associated with a
potential US Fed rate hike later this year (which seems somewhat accommodative given the market pegs a
hike by December as a coin toss [i.e., a 50:50 probability]), which would not only mean higher interest costs,
but higher service costs as higher implied inflation would likely mean higher wages.
~

>

Axiomcapital.com

>

DO NOT FORWARD (please help us protect your edge)

Page 19 of 28

Caterpillar, Incorporated
September 7, 2016

Exhibit 26: Total Pension Cost (Benefit) Included in Operating Profit

$550
Polysilicon
>40 play ers

$s millions
Ingot/Wafer
~50 pla yers

$450

$350

Cells

~100

Module ~ 400

CAT's
12/31/15 recast of its pension expense
play ers
play ers
provides a $20mn benefit 1H16 vs. 1H15, and a
$378mn adjustment (in favor of CAT) to operating
costs in 1H15 (i.e., accounting chicanery). And... it's
2016 guide includes the benefits associated w/ the
accounting change, yet excludes any potential neg.
mark-to-mark impacts from plan remeasurements.

System > 5,000

pla yers

$250

$150

$50

($50)
1Q13A 2Q13A 3Q13A 4Q13A 1Q14A 2Q14A 3Q14A 4Q14A

1Q15 2Q15 1Q15 2Q15 1Q16 2Q16

Original Original Restmnt Restmnt New
New
Method Method

Source: Company filings, Axiom Capital research.

Exhibit 27: CATs Comments on what its 2016 EPS Outlook Does Not Include as it Relates to Pension Accounting Change, and
Polysilicon

Ingot/Wafer

Cells

~100

Module ~ 400

System > 5,000

Operating
metric
to
profit change relativeplatoyers
the change
>40Profit
play ers Pull Through A key
~50
pla yers used by management
play
ersmeasure the rate of operating
play ers
Polysilicon
Ingot/Wafer
Cells ~100
Module ~ 400
System > 5,000
in sales
revenues. The metric is~50defined
profit divided by theplay
change
in sales and revenues.
Excludes
>40and
play ers
pla yers as the change in operating
play ers
ers
pla yers
restructuring costs and mark-to-market gains or losses resulting from pension and OPEB plan remeasurements.
Source: C2Q16 earnings transcript, Axiom Capital research.

Exhibit 28: CATs Comments on what its 2016 EPS Outlook Does Include as it Relates to Pension Accounting Change
Polysilicon
>40 play ers

Ingot/Wafer
~50 pla yers

Polysilicon

Ingot/Wafer

>40 play ers

~50 pla yers

Cells

Module ~ 400

Cells

Module ~ 400

System > 5,000

play ers

pla yers

~100
play ers
~100
play ers

play ers

System > 5,000

pla yers

Note: See highlighted section above for CATs intentions around recognizing any potential adverse pension costs associated with plan remeasurements.
Source: Page 5 of CAT 3/17/16 BAC conference presentation, Axiom Capital research.

Axiomcapital.com

DO NOT FORWARD (please help us protect your edge)

Page 20 of 28

Caterpillar, Incorporated
September 7, 2016

Adjustments to the way Segments are Reported: January 1, 2014 CAT materially recast its segment
reporting. At the time, the reason given, according to CAT, centered on: responsibility for paving products,
forestry products, industrial and waste products and tunnel boring equipment moved from Resource
Industries to the All Other operating segments. Additionally, the responsibility for select work tools was
moved from Resource Industries to Construction Industries, and the responsibility for administration of three
wholly-owned dealers in Japan moved from Construction Industries to the All Other operating segments.
Then, January 1, 2015 CAT again materially recast its segment reporting. The reason given, according to
CAT, centered on: responsibility for product management for certain components moved from Resource
Industries to Energy & Transportation.
Yet, leaving us speechless, again January 1, 2016 CAT materially recast its segment reporting, this time
making even more changes than in the past. What were those reasons? Well, according to CAT:
Responsibility for remanufacturing of Cat engines and components and responsibility for on-highway
vocational trucks moved from the All Other segments to Energy & Transportation. Responsibility for forestry
and paving products moved from All Other segments to Construction Industries. Responsibility for industrial
and waste products moved from All Other segments to Resource Industries. Internal charges for component
manufacturing and logistics services provided by All Other segments to Construction Industries, Resource
Industries and Energy & Transportation in excess of cost have been adjusted to approximate actual cost,
resulting in a reduction in profit in the All Other segments and corresponding increases in profit in the other
three segments. Costs that previously had been included in ME&T Corporate Items, primarily for companywide strategies such as information technology and manufacturing process transformation, have been
included in the ME&T segments that benefit from the costs.
Overall, we see the nearly annual recasting of CATs segmentation results by management as making
financial analysis of the company much more convoluted (and, in many cases, impossible historically). At
risk of stating the obvious, we see this as a red flag.

Aggressive Restructuring Allowances: As detailed here, we remind our readers that by taking large, onetime, restructuring charges when times are bad (or, in the case of CAT, nearly every single quarter
Exhibit 29), with respect to one-time items, companies: (a) sometimes use these charges to bury
unfavorable expenses or investments that went wrong, which should be recorded on the income statement,
where investors could clearly see the true negative effect on the company's net income, and with respect to
restructuring allowances, companies often (b) artificially reduce depreciation in future periods and ultimately
increase income.

Axiomcapital.com

DO NOT FORWARD (please help us protect your edge)

Page 21 of 28

Caterpillar, Incorporated
September 7, 2016

Exhibit 29: CAT is a Serial Offender of Aggressive One-Time Quarterly Restructuring Charges Is this Fantasy Accounting?
Polysilicon

Ingot/Wafer

>40 play ers

~50 pla yers

Cells

~100
play ers

Module ~ 400

System > 5,000

play ers

pla yers

Source: Company filings, Bloomberg, Axiom Capital research.

So whats the current scorecard here? Well, when CAT reported C2Q16 figures 7/26/16, it upped its
expected 2016 restructuring charges to $700mn (which allows the company to take a lot of costs out of
Polysilicon
Ingot/Wafer
Cells
100
400
System 5,000
non-GAAP
EPS, painting
a yers
picture of EPS that
may
be closer toModule
fantasy
versus a real
depiction
of
40 play ers
50 pla
play ers
play ers
pla
yers
underlying fundamentals), from $500mn previously (i.e., when C1Q16 numbers were reported), and
$400mn when C4Q15 figures were reported 1/28/16. Stated differently, while we acknowledge risk around
shorting a company that is engaging in producing what we see as targeted/fantasy EPS, ultimately we feel
this weakens investor trust in the reporting company. Furthermore, as detailed in Exhibit 2 above, while
CAT saw its restructuring charges balloon through the majority of the 1980s, outside of 1987, the company
underperformed the S&P 500 the entire decade. As such, with our adjusted (i.e., including an inorganic
restructuring boost benefit) 2016 and 2017 EPS numbers materially below Consensus, and likely insufficient
to cover CATs 2015 dividend payout (i.e., a key pillar to the bull thesis), we see outsized risk to CATs
current forward P/E multiple of 21.7x.
~

>

Axiomcapital.com

>

DO NOT FORWARD (please help us protect your edge)

Page 22 of 28

Caterpillar, Incorporated
September 7, 2016

Our Updated Estimates

Our Bottom-Up Model Suggests CAT will Not Earn Its Dividend, Even When Adjusting for Restructuring,
in 2H16; This Headwind Appears Set to Worsen in 2017. In Exhibit 30 below, we detail the key inputs that
make up our 2016 and 2017 earnings estimates for CAT. More specifically, of note, while CAT has consistently
not earned its dividend on a GAAP EPS basis since C3Q15 (barring C2Q16), even when adjusting for
restructuring, our model suggests CATs non-GAAP EPS will be insufficient to cover its dividend
beginning in C3Q16 in fact, using the Consensus estimate for CATs 2016 GAAP EPS of $2.81, even our
more bullish peers (CAT has 4 BUYS, 18 HOLDS, and 3 SELLS) acknowledge that the company is not earning
its dividend when factoring out all of the restructuring/favorable-pension-accounting/favorable-reserveaccounting. Thus, at risk of stating the obvious, paying a dividend out of cash is not the most efficient use of
cash; it is also somewhat of a surreptitious risk as a companys valuation could come under risk should
investors begin to question when and/or whether the dividend is imminently likely to be cut (we believe CAT will
cut its dividend at some point in 2017).
Exhibit 30: Axiom Capital CAT Bottom-Up Model (Short-Form) 2015A-2017E
Polysilicon
>40 play ers

Ingot/Wafer

Fiscal Year-End:
December
- $s millions
~50 pla
yers

Cells

~100
play ers

Fiscal
2015

Fiscal
2016E
play ers

Module ~ 400

Fiscal
2017E

Construction Inudstries
seq. change %
Operating income
Operating Margin%

$16,568
-14.4%
$1,925
11.6%

$15,398
-7.1%
$1,507
9.8%

$14,225
-7.6%
$1,329
9.3%

Resource Industries
seq. change %
Operating income
Operating Margin%

$7,551
-15.4%
($88)
-1.2%

$5,966
-21.0%
($344)
-5.8%

$4,831
-19.0%
($169)
-3.5%

Energy & Transport

seq. change %
Operating income
Operating Margin%

$17,938
-17.4%
$3,239
18.1%

$14,491
-19.2%
$2,194
15.1%

$13,863
-4.3%
$2,109
15.2%

All Other Segments

$2,197

$1,046

$1,056

CAT Financial incl. Corp Eliminations

seq. change %
Operating income
Operating Margin%

$2,864
-5.9%
$809
26.3%

$2,726
-4.8%
$693
23.8%

$2,654
-2.6%
$672
23.6%

EBITDA

$6,302

$5,234

$4,079

Revenue
Consensus
EPS
Restructuring
EPS excl. Restructuring
Consensus
Dividends per share (DPS)

$47,011

$39,524
$40,117
$2.19
$0.84
$3.03
$3.53
$3.08

$36,527
$39,663
$0.84
$1.48
$2.31
$3.58
$3.08

$3.50
$1.15
$4.65
$3.01

System > 5,000

pla yers

Source: Company filings, Axiom Capital research.

Polysilicon
Axiomcapital.com
>40 play ers

Ingot/W
afer
DO
NOT
~50 pla yers

~100 help us protect

Module
~edge)
400
FORWARDCells
(please
your
play ers
play ers

System
Page> 5,000
23 of
pla yers

28

Caterpillar, Incorporated
September 7, 2016

Moving to our quarterly estimates, we see a modest miss coming in C3Q16, morphing into a more sizeable
miss in C4Q16 (Exhibit 31). Our conviction around a sizeable shortfall in CATs C4Q16 earnings centers on
both quantitative and qualitative factors. First, with respect to the qualitative factor, we note that CATs ESTIP
design focused on providing a bonus pool when EPS is equal-to-or-in-excess of $3.50/share ends exiting 2016,
meaning, we believe, the company will likely focus on managing C4Q16 EPS to a steady-state materially
below $3.50/share annualized even when including restructuring charges, as well as benefits from favorable
pension and reserve accounting. Moving to the quantitative factor, referencing Exhibit 11 again, where we
highlight that 1H16 orders are running 18.1% below 1H15 orders, and keeping in mind that orders lead sales,
we believe CAT may take C4Q16 guidance as an opportunity to adjust forward expectations on EPS lower
taking its proverbial lumps if you will as we project materially weaker actual results in C1Q17 will prove
unavoidable, even with all the accounting magic the company has mustered thus far.
Exhibit 31: Axiom Capital CAT Bottom-Up Model (Short-Form) 2015A-2017E
Polysilicon
Fiscal Year-End:
December - $s millions
>40 play ers

Fiscal 2015
Q1 Ingot/W
Q2afer
Q3
~50 pla yers

Q4

Cells Q1
~100
play ers

Fiscal 2016E
Q2
Q3E Module
Q4E~ 400
play ers

Q1E

Fiscal 2017E
System
Q2E
Q3E > 5,000 Q4E
pla yers

Construction Inudstries
seq. change %
Operating income
Operating Margin%

$4,695
6.2%
$740
15.8%

$4,441
-5.4%
$587
13.2%

$3,792
-14.6%
$378
10.0%

$3,640
-4.0%
$220
6.0%

$4,043
11.1%
$440
10.9%

$4,426
9.5%
$550
12.4%

$3,488
-21.2%
$310
8.9%

$3,440
-1.4%
$206
6.0%

$3,593
4.4%
$404
11.3%

$4,050
12.7%
$415
10.3%

$3,279
-19.0%
$295
9.0%

$3,303
0.7%
$215
6.5%

Resource Industries
seq. change %
Operating income
Operating Margin%

$1,928
-19.2%
$85
4.4%

$1,991
3.3%
$0
0.0%

$1,796
-9.8%
($68)
-3.8%

$1,836
2.2%
($105)
-5.7%

$1,449
-21.1%
($96)
-6.6%

$1,457
0.6%
($163)
-11.2%

$1,501
3.0%
($23)
-1.5%

$1,559
3.9%
($62)
-4.0%

$1,115
-28.5%
($72)
-6.5%

$1,060
-5.0%
($13)
-1.2%

$1,261
18.9%
($28)
-2.2%

$1,395
10.7%
($56)
-4.0%

Energy & Transport

seq. change %
Operating income
Operating Margin%

$4,762
-23.1%
$986
20.7%

$4,544
-4.6%
$906
19.9%

$4,213
-7.3%
$635
15.1%

$4,419
4.9%
$712
16.1%

$3,278
-25.8%
$410
12.5%

$3,750
14.4%
$602
16.1%

$3,545
-5.5%
$585
16.5%

$3,917
10.5%
$597
15.3%

$3,104
-20.8%
$497
16.0%

$3,563
14.8%
$552
15.5%

$3,377
-5.2%
$507
15.0%

$3,819
13.1%
$554
14.5%

All Other Segments

$586

$637

$506

$468

$38

$41

$501

$466

$39

$41

$500

$477

CAT Financial incl. Corp Eliminations

seq. change %
Operating income
Operating Margin%

$741
-0.4%
$227
28.6%

$734
-0.9%
$184
23.4%

$677
-7.8%
$207
27.5%

$712
5.2%
$191
25.6%

$681
-4.4%
$168
22.6%

$697
2.3%
$202
26.6%

$673
-3.4%
$162
22.9%

$675
0.2%
$161
22.8%

$668
-0.9%
$183
25.0%

$659
-1.4%
$171
23.8%

$659
0.0%
$159
22.9%

$668
1.3%
$160
22.8%

EBITDA

$2,280

$1,891

$1,471

$660

$1,234

$1,539

$1,308

$1,153

$991

$1,100

$1,024

$964

Revenue
Consensus
EPS
Restructuring
EPS excl. Restructuring
Consensus
Dividends per share (DPS)

$12,702
NM
$1.81
$0.04
$1.86
NM
$0.00

$12,317
NM
$1.16
$0.11
$1.27
NM
$1.47

$10,962
NM
$0.62
$0.13
$0.75
NM
$0.00

$11,030
NM
($0.15)
$0.89
$0.74
NM
$1.54

$9,461
NM
$0.46
$0.21
$0.67
NM
$0.00

$10,342
NM
$0.93
$0.15
$1.09
NM
$1.54

$9,686
$9,927
$0.50
$0.24
$0.74
$0.77
$0.00

$10,034
$10,432
$0.29
$0.24
$0.53
$1.02
$1.54

$8,491
$9,467
$0.17
$0.37
$0.54
$0.74
$0.00

$9,343
$10,368
$0.32
$0.37
$0.68
$1.04
$1.54

$9,054
$9,800
$0.22
$0.37
$0.59
$0.82
$0.00

$9,639
$10,347
$0.13
$0.37
$0.50
$0.95
$1.54

Source: Company filings, Axiom Capital research.

Polysilicon

Ingot/Wafer

>40 play ers

~50 pla yers

Axiomcapital.com

Cells

~100
play ers

Module ~ 400

System > 5,000

play ers

pla yers

DO NOT FORWARD (please help us protect your edge)

Page 24 of 28

Caterpillar, Incorporated
September 7, 2016

Exhibit 32: CAT Backlog Progression

Polysilicon

Ingot/Wafer

>40 play ers

~50 pla yers

Cells

~100
play ers

Module ~ 400

System > 5,000

play ers

pla yers

Source: Company filings, Bloomberg, Axiom Capital research.

Polysilicon

Ingot/Wafer

>40 play ers

~50 pla yers

Axiomcapital.com

Cells

~100
play ers

Module ~ 400

System > 5,000

play ers

pla yers

DO NOT FORWARD (please help us protect your edge)

Page 25 of 28

Caterpillar, Incorporated
September 7, 2016

Risks to Our Thesis

While we have strong confidence in our views expressed throughout this report, we do acknowledge a number
of risks to our downside 2017 year-end price target. Below, we provide some perspective on these risks.

Mustering More Magical Restructuring/Pension/Reserve Accounting to Achieve $3.50/share in

2016 EPS. As detailed throughout this report, recently CAT has resorted to aggressive, and in some cases,
we believe, overly aggressive accounting tactics to boost non-GAAP EPS. Thus, should management be
looking for one more pay day, more magical accounting could be employed to boost the non-GAAP 2016
EPS number to $3.50/share.

US Presidential Sentiment Boost. Should the 2016 US Presidential election be close, key swing states
such as Ohio, Illinois, Virginia, etc. could become a focus. Should that be the case, as weve seen in prior
elections, rhetoric around support for the coal industry and infrastructure could pick up, driving a sentiment
boost for US industrial stocks.

Unforeseen Growth. While hindsight is always 20/20, seeing the next big economic expansion is inherently
more difficult. Despite a slowdown in China and Latin America, an unforeseen catalyst to economic growth
that could emerge, ignoring boom-and-bust cycles, may result in the need for additional infrastructure (i.e.,
the emergence of Silicon Valley helped bring the need for increased infrastructure in surrounding areas).
Should this unforeseen growth occur, our thesis could prove invalid.

CAPEX Budgets Beat Expectations. While we expect CAPEX budgets to meaningfully soften through
2017, based on Consensus estimates, weighing on CATs top line, should CAPEX spending come in above
expectations, our thesis could prove invalid.

Attractive Dividend. Given the Federal Reserve has yet to cut interest rates, and may not for the
remainder of this year, we acknowledge some investors may find CATs current dividend yield attractive,
which may serve as a deterrent to selling the stock even should our fundamental analysis prove accurate.

Stronger Dollar. Continued strength in the USD could benefit CAT. Despite the companys presentation
currency being USD, a substantial amount of its manufacturing costs are located abroad. Thus, while
foreign revenues would translate to fewer dollars in an appreciating USD environment, CATs costs would
likely more than offset this, resulting in inorganic margin expansion.

Share Buybacks. Noting the depth remaining in CATs current share repurchase program, which expires in
2018, if the company were to expand upon this plan or initiate a new plan, per-share performance metrics
could materially rise. This would likely be viewed by the market place as a positive, but would represent a
negative to our thesis.

Please contact your Axiom Capital Research sales person for our bottom-up CAT company model.

Axiomcapital.com

DO NOT FORWARD (please help us protect your edge)

Page 26 of 28

Caterpillar, Incorporated
September 7, 2016

Analyst Certification:
I, Gordon Johnson, attest that the views expressed in this research report accurately reflect my personal views about the subject security and issuer.
Furthermore, no part of my compensation was, is, or will be directly or indirectly related to the specific recommendation or views expressed in this
research report.
Explanation of Ratings
Outperform/Buy We expect the stock to outperform the S&P 500 Index and post absolute price appreciation of at least 10%.
Neutral/Hold We expect the stock to perform in line with the S&P 500 Index.
Underperform/Sell We expect the stock to underperform the S&P 500 Index and post absolute price depreciation of at least 10%
Current distribution of ratings as of September 7, 2016
Rating

Number

Outperform/Buy

13

36%

Neutral/Hold

17%

Underperform/Sell

17

47%

Investment banking services were not provided to any of the companies with the aforementioned ratings. All current required disclosures are available
rd
by contacting: Compliance Department at 780 Third Avenue, 43 Floor, New York, NY 10017
Valuation Methods for Fundamental Analysis
One or more of the following valuation methods are used in making a price projection: Analysis of the supply and demand for a security to ascertain
how high or low a stock price may move before either overhead supply or underneath demand develops; Analysis of a companys P/E ratio, price/book
ratio, price/cash ratio, earnings expectations or sales growth as they relate within an industry group or to the broader market; Dividend yield of the S&P
500 vs. the yield of the 10-year government bond; Individual sector analysis along with investor sentiment, and Federal Monetary Policy.
Valuation Methods for Technical Analysis
Valuations are based on technical analysis techniques using some or all of the following inputs: trend recognition, pattern recognition, Japanese
candlestick formations, oscillator readings (short-term), relative performance, money flows, support and resistance levels, volume, sentiment indicators,
and seasonal analysis.
This communication is neither an offer to sell nor a solicitation of an offer to buy any securities mentioned herein. This publication is confidential and for
the information of the addressee only and may not be reproduced in whole or in part, copies circulated, or disclosed to another party, without the prior
written consent of Axiom Capital Management, Inc.
This material has been prepared by Axiom Capital Management, Inc., a registered U.S. broker-dealer, employing appropriate expertise, and in the belief
that it is fair and not misleading. Axiom Capital Management, Inc. accepts no liability for loss arising from the use of the material presented in this
report, except that this exclusion of liability does not apply to the extent that such liability arises under specific statutes or regulations applicable to
Axiom Capital Management, Inc. This report is not to be relied upon in substitution for the exercise of independent judgment. Axiom Capital
Management, Inc. may have issued, and may in the future issue, other reports that are inconsistent with, and reach different conclusions from, the
information presented in this report. Those reports reflect the different assumptions, views, and analytical methods of the analysts who prepared them
and Axiom Capital Management, Inc. is under no obligation to ensure that such other reports are brought to the attention of any recipient of this report.

Axiomcapital.com

DO NOT FORWARD (please help us protect your edge)

Page 27 of 28

Caterpillar, Incorporated
September 7, 2016

Past performance should not be taken as an indication or guarantee of future performance, and no representation or warranty, express or implied, is
made regarding future performance. Information, opinions, and estimates contained in this report reflect a judgment at its original date of publication
by Axiom Capital Management, Inc. and are subject to change without notice. The price, value of, and income from any of the securities mentioned in
this report can fall as well as rise. The value of securities is subject to exchange rate fluctuations that may have a positive or adverse effect on the price
or income of such securities. Investors in securities such as ADRs, the values of which are influenced by currency volatility, effectively assume this risk.
Securities recommended, offered, or sold by Axiom Capital Management, Inc.: (1) are not insured by the Federal Deposit Insurance Corporation; (2) are
not deposits or other obligations of any insured depository institution; and (3) are subject to investment risks, including the possible loss of principal
invested. Indeed, in the case of some investments, the potential losses may exceed the amount of initial investment and, in such circumstances; you
may be required to pay more money to support these losses.
We and our affiliates, officers, directors, and employees, excluding equity analysts, will from time to time have long or short positions in, act as principal
in, and buy or sell, the securities or derivatives (including options and warrants) thereof of covered companies referred to this research.
ADDITIONAL DISCLOSURES
The analyst or a member of the analysts family holds a stock or options position in the following securities mentioned in this report: None.
Options Disclosures
Options are not suitable for all investors and not all options strategies are suitable for all investors who may be suitable to trade options. At or prior to
being approved for options trading, investors must be given and should read Characteristics and Risks of Standardized Options, the risk disclosure
booklet issued by the options exchanges. All accounts must meet options suitability requirements prior to any options trading. Options strategies may
entail significant risks. Certain strategies may contain risks beyond the initial investment and cause the investor to incur losses beyond such investment.
Risks associated with the strategies contained herein are included in the discussions on breakeven point, maximum risk and maximum loss discussions,
to the extent applicable. Annualized returns cited in this report may be achieved only if the parameters described can be duplicated and there is no
certainty of doing so.
Axiom Capital Management, Inc. previously provided to you a copy of the booklet entitled Characteristics and Risks of Standardized Options. A current
rd
copy of this booklet may be obtained by calling Eric Miller or by sending a written request to: Axiom Capital Management, Inc. at 780 Third Avenue, 43
Floor, New York, NY 10017.

Axiomcapital.com

DO NOT FORWARD (please help us protect your edge)

Page 28 of 28