Q3 2019 Earnings Call
Good morning, ladies and gentlemen, and welcome to the Caterpillar Three Q2 019 Analyst Conference.
At this time all participants are in place I don't listen only mode and we will open the floor for your questions and comments. After the presentation and is now my pleasure just trying to flip over to your host Jennifer Driscoll ma'am the floor is yours.
Thanks Catherine.
Good morning, everyone and welcome to Caterpillar's third quarter earnings call at our new earlier time of 730 am central.
Joining us today, our Jim Umpleby chairman of the board and CEO .
Andrew Bonfield CFO .
Athlete Vice President of our Global Finance services Division and Rod Wrangle Investor Relations manager.
Our call today expands on our earnings release, which we issued earlier this morning, you'll find slides to accompany today's presentation along with the release.
Yes, your section of Caterpillar dotcom under events and presentations.
The forward looking statements, we make today are subject to risks and uncertainties.
Awesome make assumptions that could cause our actual results to be different an information we discussed today.
Please refer to our recent FCC filings and the forward looking statements remainder in today's news release for details on factors the individually or combined could cause our actual results very very materially from our forecast.
We remind you that caterpillar has copyrighted this call and we prohibit use of any portion of that without prior written approval.
We're not reporting adjusted profit per share today, but remember we will at the end of the fourth quarter. This will exclude any mark to market gain or loss for the remeasurement of pension and other post employment benefit plans as well as any other material discrete items.
As a reminder, our U.S. GAAP based guidance for private per share continues to include the benefit of the 31 cent discrete tax item, we recognized in the fourth first quarter.
In a moment, you'll hear from Andrew with a summary of this quarter's financial results, but first let me turn the call over to Jim for our third quarter highlights which appear on slide three thank you.
Thank you Jennifer good morning, welcome to caterpillars third quarter earnings call.
First I'll cover our third quarter results at a high level and give you my perspective on the key factors influencing our performance.
I'll then provide some context for our decision to lower or 2019 guidance and will discuss our expectations for the external environment.
The primary factor impacting our third quarter results was lower volume driven by reductions in dealer inventory and lower than expected demand from end users.
Sales and revenues declined 6% during the quarter, mostly due to construction industries in resource industries.
During the third quarter of 2018 dealers increased inventory by $800 million in anticipation of increasing end user demand.
This compares to a decline of $400 million in dealer inventory during the third quarter of 2019.
Quarter over quarter change of $1.2 billion.
Although the retail sales data we released this morning reflected an increase of 6% for both machines in energy and transportation, we believe dealers reduced inventory due to uncertainty in the global economy, resulting from trade tensions and other factors.
We've also made progress reducing our lead times, which allows dealers to maintain less inventory.
Order lead times allows caterpillar and or dealers to more quickly adapt to changing market conditions.
We are taking steps to reduce production to match dealer demand.
Our third quarter operating profit decreased 5% driven primarily by lower volume.
We maintained our operating profit margin percent, despite lower volume in some continued pressure on manufacturing costs.
We anticipate meeting the full year operating margin targets communicated during our Investor day last may.
Turning to the full year on slide four we lowered our guidance for 2019 this morning.
We now expect profit per share for the full year to be between $10.90 and $11.40 versus our prior guidance of the low end of the range of $12.06 to 13 Dollarssix sense.
Those ranges include the benefit of the 31 cents discrete tax item in the first quarter.
Our revised outlook is primarily the result of caution being displayed by our dealers and customers due to uncertainty in the global economic environment.
You'll recall that during our second quarter earnings call, we expected dealers to reduce inventories by about $900 million during the last six months of the year.
We now anticipate the dealers will reduce their inventories by about $1.3 billion versus second quarter levels.
This includes a decrease of approximately $900 million during the fourth quarter.
As a result, our production in shipment to dealers are the balance of the year will be lower than we previously anticipated.
As I mentioned earlier to retail sales figures. We released this morning showed growth of 6% for machines in energy and transportation.
However, based on input from dealers and customers. We now expect fourth quarter end user demand to be about flat compared to the fourth quarter of 2018.
Based on our revised expectations for dealer inventory and end user demand, we now expect sales and revenues to be modestly lower for the full year versus our prior expectation of modest sales and revenue growth in 2019.
The global economic situation is very fluid due to a variety of factors.
The decline in dealer inventory, along with our improved lead times will position us to react quickly to positive or negative developments in the global economy during 2020.
As I mentioned, we're taking actions to reduce production levels reflect dealer order patterns, you will be ready to increase production if order levels improve.
We're also taking action in other areas to improve the competitiveness and flexibility of our cost structure, which Andrew will expand upon shortly.
During our Investor day in May we shared our intention to drive long term shareholder value by returning substantially all of our machinery energy and transportation free cash flow to shareholders through a competitive dividend and the more consistent share repurchase plan.
Our balance sheet remains strong.
During the third quarter, we paid a quarterly dividend of one dollarsthree per share representing a 20% increase over the previous quarter.
As previously communicated we expect to increase our dividend by the high single digit <unk> percent during each of the next four years continuing its a dividend aristocrats.
Our most recent dividend increase reflects the company's confidence in our ability to achieve improved free cash flows through the cycle as we discussed in may.
We also repurchased $1.2 billion of common stock in the third quarter.
We continue to expect share repurchases during the second half of the year will be similar to the first half, which will reduce our total quarterly average diluted shares outstanding by about 9% since the first quarter 2018.
Now, let me comment further on our expectations for the external environment.
In construction industries, we continue to anticipate North America end user demand to be higher than 2018, because of strength in state and local infrastructure in nonresidential construction activity.
At the same time, we expect dealers to reduce their inventories in North America from current levels.
Turning to Asia Pacific, we expect stimulus to healthy industry in China, although the industry has weakened to outside of China and Japan.
We expect dealers in China to build inventory due to an earlier Chinese new year in 2020.
This will partially offset the decline in North America.
We anticipate that E. Amy construction activity will be lower than 2018, as we are seeing weakening demand in Europe , while Africa in the middle East are likely to remain challenged.
We anticipate Latin America will continue to grow but from a low level.
Well resource industries, most commodity prices remain at investable levels with the exception of thermal coal which remains weak.
Quoting activity in the end user demand for mining equipment remains positive and larger mining trucks have further room for growth.
We continue to believe we are in the early stages of a multiyear recovery in mining however, miners are cautious due to economic uncertainty.
Meanwhile, we expect softer demand for nonresidential construction inquiry in aggregate equipment as dealers further reduce their inventory.
Turning to energy and transportation, we expected oil and gas will continue to be volatile based on oil price fluctuations in reduced capital spending for well servicing.
Take away capacity constraints in the Permian basin have improved but overall industry demand remains relatively depressed.
For gas compression reciprocating gas.
Engine sales for gas gathering have slowed but solar turbans gas compression business in North America remains strong.
Power generation continues to be an area of expected growth.
We continue to anticipate that solar turbines and progress rail we're both have strong fourth quarter.
Please turn to slide five.
We continue to execute our strategy for profitable growth, which has three pillars services operational excellence and expanded offerings.
At our Investor day in May we announced our goal to double machinery energy and transportation services sales between 2016 2026.
This target is challenging you had achievable.
By growing our services, we will help our customers improve asset utilization and availability, while reducing their owning and operating cost.
We're continuing to invest to drive services growth, including expanding our digital capabilities.
We continue to connect assets and invest in our digital architecture to provide actionable actionable insights to our customers.
For example, our cat inspect app helps customers identify the maintenance needs of a machine and plan accordingly.
We're seeing close to 100000 inspections on the EPS per month.
In the area of operational excellence, we use lean principles at our large engine facility in Lafayette, Indiana to improve safety enhance engine quality and achieve greater manufacturing efficiencies.
Lean improvements drove a 40% reduction in assembly time for our large 3600 engines, allowing us to produce more engines from the same facility, while improving safety and quality.
Dry for operational excellence is a never ending journey.
Lean is helping us to respond more quickly to changes in industry demand.
And the final pillar of our strategy is expanded offerings enable lead us to grow our business by addressing the diverse needs of our customers around the world.
We introduced a new dynamic gas blending or de GB engine for well servicing customers.
The new tier four engine, which is unique in our industry allows customers to replace up to 85% of diesel fuel with natural gas.
Our GGB product helps our oil and gas customers to be more successful by improving operating economics by offering fuel flexibility.
We're continuing to offer continuing our focus on autonomy somebody autonomy in remote operation as we expand or offerings.
We believe caterpillar leads our industry in all three areas.
Some of our early customer subsided productivity benefits of up to 30% using cat autonomous mining solutions.
Addition, our customers are seen real improvements in safety in some cases up to a 90% reduction safety incidents.
One of our competitive advantages is that we can retrofit our competitors equipment, making autonomous solutions an option for mixed fleets.
We're encouraged by the recent wins we've had in autonomy this year.
With that I'll turn the call over to Andrew for a closer look at our financials. Thank you Jim and good morning, everyone.
I'll begin on slide six once a quarter results focusing in particular, what drove the topline.
Then I'll turn to our revised outlook before finishing on capital deployment.
So some good news so quota declined by 6% to $12.8 billion.
Operating profit decreased by 5% to $2 billion.
<unk> per share declined by 8% to to go 66.
Overall, our results were lower than we'd expected.
This quarter was largely volume story.
She sees on slide seven sales volume declined by $751 million.
Destruction industries and this was industries drugs this decline.
The unfavorable currency movements caused by the Euro Australian dollar.
It's important to understand the meeting pause behind the booking figures as Jim mentioned the primary driver was changes ddas made the inventories.
If the impact of this year on year trains, which we excluded from our topline results. The underlying sales performs well be in love with the growth we reported reach she sells statistics this morning.
We expect to see dealer inventories confidence quota.
So club that makes you want to discuss changes throughout 2019.
Now, let me discuss individual segments.
Firstly on Saturday, So strong margin performance from energy and transportation, which is not surprising as a second half tends to be stronger for that business.
Despite a 2% sells the time segment profit increased by $48 million, 5%, mainly due to lower incentive compensation expense.
Segment margin funds, 18.7% certain sales an expansion of 120 basis points.
In resource industries shown in slide mine the impact of lower volumes on high warranty expenses, which were partially offset by favorable price realization goes the margin down by 220 basis points.
Total sales decreased by 12% and segment profit decreased 25 to send to 13.5% of sales.
The topline performance was driven by changes and people are buying patterns.
He does increase and the trees and third quarter 2018, well say decrease and this and this quarter.
Margins and resource industries are the most sensitive to fluctuations of body.
In the first and second quarter those margins was strong driven by the leverage associated volume growth.
I would expect the fourth quarter to show similar patents in the third quarter, but overall, we expect full year margins for the segment to be higher than that was in 2018.
Now turning society.
Construction industry sales declined by 7% due to reduced volumes.
Sales in the Asia Pacific region slowed flows is a strong third quarter last year as ddas decreasing countries, particularly in China, whose is an increase in the prior year.
Good morning America, we saw some Instagram sales talked road in nonresidential good.
In the September Rolling three month cells to use the types of published this morning showed an increase of 4% mode, while dealer sales and construction equipment.
We continue to develop amongst new products around the world, helping our customers within the unique environments enabled us to extend this growth over the long term.
The segment margin fell by 80 basis points to 17.8%.
For a price continues to offset manufacturing costs negative bought even mix with greater than the impact of lower short term compensation expense.
Let's move to slide 11 for discussion about profit performance.
Altogether third quarter operating profit decreased by 5%.
Good volume to kinda spoke about earlier it was the main driver the change year over year.
Overall margin structure remains healthy.
Although in absolute dollar trends, both had moderation third quarter price realization continues to offset increases in manufacturing costs.
Obviously, possibly rise from as low as we lapped the mid year price increase in 2018.
But equally we have seen the rates of growth in maturing afraid close mode rights as we've gone post the source of the significant changes in 2018.
I profit margin was 15.8% to salesmen using slickwater snack versus the prior.
Let me talk you through some of the headwinds and tailwinds outside of the impact to operating profit.
Suddenly tailwinds food costs at the time, how to impart by those who works incentive compensation expense.
That's a headwinds as I mentioned, a moment ago, we incurred higher warranty expense from products and resource industries. This is a very low levels in 2018.
We continue to address some targeted product quality issues, as we focus and ensuring that customers enjoy the performance and closely they expect from that products.
We also experienced some negative operating leverage associated with slowing production due to the low volumes.
We are still experiencing some inefficiencies associated with supply constrains and product launches.
Turning to the outlook on slide 12.
Let me comment briefly on the full yeah, we're a bit before turning to our fourth quarter expectations.
As Jim mentioned, we have lowered I knew gardens.
A new outlook is based on changes in assumptions around end user demand and revised expectations would do the inventory reduction caution on the part about Telus and end user customers.
Related to our load dealer inventory expectations. This will mean that we will have less of an overhang from dealer inventory as we move into 2020 .
How is the other implication of this changes that we need to manage production and reduced shipments to dealers the bones yeah.
Jim also mentioned end user demand is expected them.
Lead this reflects in customers delaying purchases of cap equipment and lots of the uncertainty this in the business environment.
Our assumption of modestly goes so some good news for the full year 2019 flows from these changes to our expectations.
Both of these factors also flowing into the order backlog, which was $14.6 billion view into the third quarter about 400 million, though in the second quarter.
More tobacco decrease most in construction industries and resource industries.
We believe this decline reflects a combination of our improved availability.
These expectations for low demand from Denmark is in the fourth quarter and fetus designed to reduce inventory levels.
However, it is difficult isn't just aggregate this decline into each of these components.
Therefore, we continue to closely monitor and user demand commercial shipments dealer inventory orders and backlog and adjust our production levels accordingly.
As many of you know idealism independent entities and control building inventories.
Our goal remains to strike a balance between satisfying to see the demand and avoiding access midstream system.
We're also taking actions in other areas of our cost structure.
Particularly around things like Jim will the minister co sections.
What would be gum projects in a couple of these areas. We don't expect to recognize the benefits in the short term.
We're committed to maintaining a competitive inflexible cost structure and we all controlling discretionary spend.
As we said at Investor Day, we are committed to improving margins by between three to six percentage points compared to historical performance.
Now, let me show, if you're going to assumptions on before.
Based on those changes and dealing with behavior I mentioned, we now expect about 900 million dollar reduction dealer inventories in the fourth quarter versus a 200 million dollar inventory build in Q4 last year.
We also now soon fresh end user demand in the fourth quarter Euro yeah.
Previously we had assumed end user demand would increase or the similar rate. So we have seen throughout the year or about 4%.
As we note on we expect to see dealer inventories.
Inventory reduced by higher sales to end users. This means that almost all of the inventory reduction has to come from most shipments from caterpillar to ideas.
Given that we now anticipate about a mid single digit decline in sales in the fourth quarter.
So the assumptions for load dealer inventory levels and low end user demand feed into load guidance. So we'll need to cut production further in the fourth quarter.
We do expect to see some negative operating leverage as a result with low production.
However, we expect this will be partially offset by favorable raw material costs as we drive the 2018 increases and pray to material costs.
In addition, we expect slightly higher warranty costs, given the increased warranty expense year to date against a very low comparative in 2018.
Obviously is very disappointing to reduce I'd gcgs yeah.
July guns took into account we have you expect we expect to dealer inventory to reduce the balance of yet.
However, the greater than expected reduction deal, we'll do some full quota and a shift on an anticipated end user demand understandably dampens our expectations.
That brings me to our capital structure on slides 13.
We're committed to returning so essentially all of that machinery energy and transportation free cash flow to shareholders through a competitive dividend along with more consistent share repurchases.
We believe that's the best way to create long term shareholder value.
Excluding the discretionary contribution to the U.S. pension plans, which I'll discuss at the moment.
Free cash flow remains strong.
That means we've been able to fund the competitive growing dividend and then TV paid about $600 million of dividends this quarter.
A recent 20 per cent dividend increase reflects the company's confidence in our ability to maintain strong cash flows across the cycles.
And to remind you said, we intend to increase the dividend by at least high single digit percentage in each of the four years.
We repurchased $1.2 billion of outcomes spoken for quota.
Can you share repurchases.
Repurchase plans consider our projected cash flows and takes into account the intrinsic value of actually is.
We will continue to be fixable and abuse of trauma Castro's more variable as a result dynamics and the external environment.
We'll be actually is the boundary to maintain flexibility and returning substantially all of our free cash flow shareholders over time.
We continue to protect share repurchases for the second all to be similar to the first off.
And we continue to expect to reduce that certain quarterly average diluted shares outstanding by about 9% from the first quarter of 2018.
Meanwhile, we continue to invest and services operational improvements and expanded offerings.
And we ended the quarter was 7.1 billion Boes a cash on hand.
You may have seen an announcement last month, we issued $1.5 billion of tenure and 30 year notes and the third quarter, enabling a $1.5 billion voluntary contribution to the U.S. pension plans.
This action increases the planes funded status lawn caterpillar to further execute our strategy of reducing volatility in that pension liability.
A secondary benefit of the contribution suite that we now don't expect to make any further contributions to the U.S. pension plans for a substantial period of time, therefore, freeing up cash for discretionary deployment.
This contribution has no impact on my credit rating metrics.
Finally, he was funded an attractive interest rates was actually part of that cost saving initiatives I said Lois out long term pension insurance related costs.
So finally, let's turn to slide 14, and recap today's key points.
The quotas sales and revenue declined by 6% and profit per share by 8% due to volume declines, but changes due to buying patterns.
We reduced our 2000 lunching profit for shell outlook range to a range when the $10 92 of those 40.
Based on expectations, the dealers will further reduce inventory levels and the end market demand for platinum the fourth quarter.
We are proactively managing production to address expect to changes in demand.
We're working on the competitiveness of that cost structure and the relentless execution of the operating execution Buddy remains the same sort of everything we do.
Overall financial position remains strong.
We remain very much commits it's a strategy of profitable growth and deployment of capital back to shareholders through growing dividend and consistent show purchases.
With that I'll hand, it over to the operator, the sort of the Q and Isis.
Thank you ladies and gentlemen, the floor is now open for questions.
How many questions or comments. Please press star one on your phone at this time [laughter], we ask that will pose your question. Please pick up your handset listened and speaker phone to provide optum sound quality.
Your first question is coming from Jamie Cook from Credit Suisse.
Your life.
Hi, Good morning, I guess, a couple of questions first on the resource side I think the sales and margins surprised people a little while the overall cotter was fairly good on you know you talked about warranty you talked about production cuts is there any way you can sort of quantify what the intact. If that was in the quarter I on the margin front and is there.
Our anything that you're seeing sort of on the order intake side to suggest that you know, there's there's more downside risk kinda sell side for 2020, and what that implies for margins on my second question bigger picture. So were in line 2020, I guess the assumption as you go into 2020 with less pretty thing in line with retail.
Demand.
Is there anyway, you can help us with other puts and takes it sounds like there's a cost cutting program that could be added as you know sort of incentive comp share count Lauer I'm just trying to think about the puts and takes that we should consider positive or negative we can make or an assumption on volumes. Thank you.
Well good morning, Jamie just a couple of comments for I think it's important to remember for resource industries that it's a mix of mining products and heavy construction Korean aggregates. So we've seen weaker sales unexpected on the heavy construction and aggregate side of the business mining sales on a year to date basis continue to be positive and.
Rebuilds in part sales remained strong across the board and the third quarter, we did see dealers reduce inventory related to heavy construction and some isolated pockets in mining for core related inventory again, I just want to emphasize that again alright doesn't include both that a heavy construction and mining so it's not just a mining store.
Sorry.
Moving on to the margins Jamie good morning, as well it really is all around volume and mix. So are the biggest rather both on a year on year and core two important basis, we'll relates to but we'll be otherwise ones. All puts and takes closely as we move through remember versus last year, we have lower short term incentive compensation.
But that is offset partly by a higher warranty.
But it does this quarter on quarter all the other items all your washing school gone to body.
Okay and.
And then moving into 2020 I mean, obviously at this stage as we said.
Situation <unk> economic outlook is very uncertain. So we are not gonna be providing sort of cells gotten school topline outlook guidance at this stage, we're still in the middle about budgeting process and things are very fluid.
I have on some things, yes, we are continuing to look at a cost structure.
I mentioned, we are looking at things like DNA and back office costs procurement costs and so forth all of those on initiatives that are ongoing and we'll continue to code. They all part of maintaining a flexible and competitive cost structure and then as far as share count as we said by the end of this year.
I will reduce the share count by about 9% a that will have a impacts of about you know obviously, though the split between twitchy 18, 2019, so there will be a bit of a tailwind from that next year, there will be a dozen but negative onshore to income incentive compensation. We expect this year to be about a 150 million.
More than a base plan dalvance he will be reset next year.
Okay, but I mean in the <unk> goal for 2020 say produce in line with retail to man, so sort of in flat market, it's not on reasonable chance you could probably grow.
Earnings.
Yeah, obviously it depends what are your assumptions on topline, yes, sorry, if you will assumption is a week or we have a flat retail market, but obviously would flow through yes.
Okay. Thank you I'll get back in Q.
Your next question is coming from Rob Wertheimer from Meles research.
In line is lives.
Yeah, good morning, and thanks for that commentary on dealer inventory and otherwise. It seems like you know you made a positive stuff and dealer inventories are going down you know up last quarter.
Going down now you know and yet that that was only maybe a vital and maybe a quarter of the total cut to revenues I'm trying to square. The circle here are the dealer sales at retail seem pretty good that we were released this morning up.
Mid single digits.
You, reducing dealer inventory and those sales were up and so I guess dealers must have really gotten more conservative on orders, but could you just talk about you know.
You know dealer inventory copying a quarter or that the overall revenue Cod and then did you see any cancellations and solar or any direct sales or larger projects.
So Rob if you think about the I think you're talking about over the full year, rather nicely in the quarter because obviously the quota we saw quite significant <unk> a year on year impacts of dealer inventory because as opportunity billion Mostra and don't 0.4. So when we started the if you remember our assumption was that actually you would have flat dealer inventories on a modest growth and so.
Sales and obviously now what we're saying is with a 500 million dollar bills or sales, we all see slightly lower sales for the full year. Yes. We are I view is the probably we lost about 2% we have on Lito.
Versus the base case guns thoughts or via a sort of factory that's been the big driver that mostly relates to expectations out there studio between the fourth quarter waste dump and quite frankly.
Moving down to flat due money is sort of 4% to 6% for the full you Oh its full year expectation was putting the top into that range, we're not going to me.
Okay.
Yes.
Yes, and I guess the question about a large order for solar and know that Solars business continues to remain strong.
Okay. Thank you.
Your next question is coming from David Raso from Evercore ISI.
Hi, Good morning, Hi, I think people just trying to figure out the regardless, where the street is for 2020, you've now kind of put out a 240 midpoint adjusted EPS for the fourth quarter.
And just trying to get a sense, you know sort of annualize that say 960.
The margins for the fourth quarter seem to be implied around 13, 13.5%.
And just trying to get a feel from you.
I know 20, Twentys, yeah, a lot of planning so going on but the approach you talked to the fourth quarter.
To get a sense of that 960 run rate or what do we feel like we're trying to a bottom.
Bottom the earnings have been here if the retail can just.
The flattish even down a bit next year.
How do you get your margins in the fourth quarter that 13, a 13.5% implied.
Is that I mean, how much of a hit is off the 900 million inventory reductions a bit of a drag.
Maybe you want to see again in 2020 that big a drag in one quarter can you just take you through your thought process on how you view the fourth quarter and those margins.
Yeah, Dave So thank you and good morning.
Of course as yours as you know is always a lowest quarter from margin perspective.
As we think through the and I production cycles, and the way overseas, a true accounting and the way we benefit from operating leverage but by volume fix or do you tend to see Q1, Q2 stronger margins Q3, slightly lower and particularly NCR you normally see a historic Lisa essentially no hall.
A drop in margin in Q4.
So that is why normally Q4 margins are lower than for the balance of the as we look for this year, obviously the dealer inventory would normally be a further reduction margin because you are having in elements of de leverage. However, there are awesome things running the other way, particularly things like lowest stood a short term incentive.
Compensation, a we also have left a lot of the material and ER freight cost increases from last year.
So that does help from an overall margin perspective.
And then we are seeing obviously last year, we did have some some negative in cat financial in particular as well and then obviously as you get to P. S. You also going to see the benefit of lower share count. So all of those factors all Whiting and as we think about but they pulled cool in the fourth quarter.
I would not leads through fourth quarter margins as being a likely margin structure as we move into 2020 . We would expect goal seasonable patents to happen in 2020 Odyssey than just depends on what the volume is and how that volume throughput flows through to variable margins.
It was sort of the spin on the question I'm in the fourth quarter's usually low I assume it's taking a little bigger hit as we said I'm feeling for reduction.
I'm running even if sales are down 5% next year, even if the margins stay that low you're still run rating ninesixty.
Right, that's assuming share repo and everything else. So just trying to get a sense. If we can all maker.
Retail demand, but it just seems like that's the fourth quarter with that margin and you. Just answered. My question. You don't think the margins should go lower than that it is sort of trying to lease baseline. This run rate earnings power I mean, a lot could change, but I. Appreciate the answer I just wanted to get a sense of how you view that fourth quarter margin. It's okay. Okay. Thank you very bunch I said.
Your next question is coming from Joel Tiss from BMO capital markets. Your line is lives.
Hey, guys has gone.
Thank you all to more than I I just wondered around pricing is you know is sort of though the bulk of the pricing or any color you can give us on a is that coming from new products and features or is that just coming more from raw material pass throughs and any sort of set up into 2020, you know how you're looking at.
Pricing potential for 2020.
Yeah. So obviously, a as I've mentioned, we did see the right to price moderates in Q3 that was as affects we've lapped the price increase that happened in the mid June as well and obviously, we all now working through the end of the beginning of the a price increase.
We have given not do is an indication price increases in 2020 , we expect price to be much more moderate in 2020 .
Obviously is depending on that will also then depending on the competitive environment as well.
As we move into into 2020 , ER and will provide a little bit more feel of that when it gets a guidance in January .
No no color around the is it more from new features and new products or is it just is just raw material related yeah. I mean, we tend not price we recognize on that on the way. We'd give you is tends to be around real price increases rather than actually makes increases. So obviously makes will go.
New product a would tend to go into the mix pocket when we looked at a mix of volume rather than price.
Okay, and then Jeff just quick for Jim any pieces of the portfolio that that you feel like you know over the next five years need to be beefed up for things that you're getting deeper into your operational excellence that maybe you know wouldn't fit and you don't happen named the pieces, but just kind of just more of a structural question of of changing the portfolio versus just returning cash.
Yeah, we continually evaluate our portfolio or we're always thinking about resource allocation and that's of course part of the already model, we've talked a lot about our intent to.
Continue to invest in services to grow the aftermarket except represents the best opportunity for future profitable growth for both us and our dealers, but in terms of change in the portfolio, we're always evaluating.
What potential changes, we could make to drive more shareholder value.
Okay. Thank you.
Your next question is coming from Courtney Ecovadis from Morgan Stanley .
Your line is lives.
Hi, Thanks, just wanted to go back to the dealer inventory de stocking affected in the fourth quarter and you know it seemed like most of that what's coming from resources and then also from APAC construction.
Corridor.
King can you just comment on you know how much oh that will be coming. Additionally for another 310th first is North America construction and when they you're also on expecting a decent amount there and then just back on on resources, where you called out Ah you know 10, the softer demand in Nonresi.
Construction and inquiry and aggregate persist thermal coal prices can you just help us understand how big a factor each of those lives and you know just take and asked for a three thinking about the fourth quarter and into 2020 on how they could attractive that's can still be or whether you're expecting replacement cycle.
Todd.
Okay. So let me saw on the dealer inventory Courtney and Hello again the a.
First you know for fourth quarter expectations all of them most of the dealer inventory reduction will come in North America, which will impact most American red cells and revenues in Q4, we actually do expect Oh and inventory build again, particularly in China in Q4, and that's part in recognition.
One of the fact is visibility Chinese new year, and obviously that means selling season, salsa, India and China next year, so that will be effect, so as we move into into Q4.
With regards to your question on Alright, I think the you know a abuse overrule you know mining probably will be yoga remain positive for the Oh, if you look up money in Capex and expectations of money Capex seven remains positive.
Sorry expectation is that will affect to be reflects fruit. If you looked at things like pump fleet.
So the lowest level since we've ever been coordinate which is since 2013. So there is latent demand then as we said we do think obviously mine is all being cautious on the capital investments, but there is the demand and replacement cycles that is needed some states, particularly on much money trucks.
I would just to remind you that is only a portion of our business. I know is often want people tend to use as we sort of Monica.
But relatively small I think obviously as far as Nonresi construction is concerned that expectation probably is you know those would be a you know that will be a drag between Q4 or has it to the particularly that as it relates to a more inventories have come out.
Maybe just to add a couple of comments currently on mining. So again, we believe we're in the early stages of a multiyear recovery in mining just given the economic turmoil going on our mining customers are being cautious and so they are hesitant to pull the trigger on new equipment. Although again, we're seeing increased sales. So we're seeing improvement in that business when they sell sticky.
Your line is that you know win win miners are sometimes delay that creates opportunities for us for rebuilt in parts of ethanol negative either so again, it's a it's an opportunity either way.
Would you characterize aftermarket is still being stronger than you would affect that otherwise.
I say that it continues to be strong swam.
Characterize it continues to be strong.
But as we expected.
Thanks.
Yes.
Your next question is coming from Ross Gilardi from Bank of America Merrill Lynch. Your line is life.
Yeah, Good morning, guys.
Hi, Rob anyway.
Just want to asking on the dividend in committing to a high single digit increase over the next four years mean, if you apply a 7% to 9% increase your dividend is 542 fiveeighty in four years I would assume you plan on covering the dividend with with earnings internally, even at the trough of the cycle.
You know what if that's the case it would seem like you're implying at least $6 a trough earnings. So I. Just wanted I was hoping you could just comment on the thought process and in your mind is there some type of minimum earnings payout ratio that you are assuming at the trough in the cycle in making that commitment to raise the dividend.
At that level, given obviously you have no visibility on what's going to happen in the next three or four years.
Oh, Hi, Ross, so if you're a and good morning, if you remember when we.
And the best today, we actually talked about in terms of cash coverage relevant Matt Sheehan earnings coverage.
And actually in cash coverage, even when our expectations of the low cycle.
Is that we would expect to actually pay on no more than 50% to 60% of Oh from free cash flows in dividends even in the low end of the cash flow cycle. Obviously cash is slightly different if you if you put cash against earnings per share.
There are obviously differences in the and the way because obviously if youre in a.
Downward cycle from <unk> revenues was makes him home you see sometimes that nice use post positive free cash flow perspective, as you all reducing working capital through that period of time, so they're all puts and takes as to why E com correlated exactly GPS.
But it does reflect confidence with obviously, we do expect both cash flows and operating margins to be positive and should reflect a that's what they told us through we'll pause from the cycle.
As we move forward.
So in saying that Andrew just just to do the math for everybody I mean.
It sounds like in your view, you think you're going to do at least $10 of free cash flow at at the bottom of the cycle.
A quick yeah, obviously, we said 4 billion to six I think is four to six putting was a range that we talked about at Investor day of a cash flow.
So obviously, yes, you can work that back through the mass.
Okay. Thanks, and then just on.
China Excavator market share I mean, there's a lot of focused on this six to nine months ago. If you look at the data your share seems to have stabilized in recent months is that correct and how has that been the case.
Have you had to match the competition with lower pricing or is it more new product innovation driven.
So.
This is Jim some market share and in any area. The world continues to be is always fluid and dynamic we've talked previously about the fact that we are introducing new products in China or Juicy product line, our dealers continue to build out their capability with a better coverage. So it's a whole variety of issues and again, it's a very dynamic situation but were.
Confident.
And our ability to compete in trying to long term, we've demonstrated the ability to do that but there will be fluctuations on a short term basis up or down that's just part of the deal.
Okay. Thank you.
Your next question is coming from Noah Kaye from Oppenheimer. Your line is lives.
Thanks, Good morning, Jim You mentioned progress this quarter with respect to shortening product lead times can you provide some more color around that I guess, particularly what's been accomplished internally.
Versus a function of easing pressure from some of these inventory reductions what did you actually accomplished in terms of making the supply chain yeah, it's been more nimble.
Good morning, it's a combination of a variety of factors we.
As discussed in previous calls that with the the sharp increase in volume and 27 in 2018, many of our supplier struggled to allow us to ER to have the lead times, who would like to given that period of of rapidly increasing demand. So there has been improving in the supply base, but as I mentioned in my in my initial remarks, we've also been.
Very focused on becoming more efficient within our factories, reducing lead times applying lean so really it's a combination of all those of all those factors.
HM.
And then on mining you know maybe a question about higher customers are viewing autonomy relative to other capex priorities you mentioned the retrofit offering you've announced several greenfield projects. We did see a case recently I believe we're one of your large mining customers was considering going autonomous, but then decided to overhaul to existing fleet and focus on productivity. It's I guess the question.
It is is that the trend or the exception is capex discipline generally holding back broader adoption of autonomous haulage or does this 30% productivity improvement from autonomy provide enough of a step change and fleet profitability that it would actually drive companies to replace or retrofit completed earlier than typical.
We spent a lot of interest in activity in autonomy I think if you look at that 30% productivity increase it really can be a game changer for many of our customers. Obviously every customer is in a very different situation and that could be a coal customer they could be a as.
In a variety of commodities so customers make decisions based on their particular financial situation, but we're very very pleased at the adoption rates that were seen in autonomy in last year or so.
You mentioned the Greenfield projects again, we do believe it's a game changer, and where we're very bullish about the outlook for that.
Capability.
Okay. Thank you.
Q.
Your next question is coming from and diagnostic for JP Morgan Securities.
In line is life.
Yes, good morning, and maybe you could address the comments you made during their bad time Asia Pacific sales I think he said have outside of China were weaker than expected to could expand on that and then what specifically are you seeing in China and kinds of end market demand and fundamentals any green shoots and that Lincoln.
Good morning, and starting with your last question first so in China. The industry as you know for US is mostly hydraulic excavators tend to have an above in the in the industry continues to be strong. So given the fact that that's.
The majority of our market in China, we have not seen a decline there. So that that's a positive as I as I did mentioned earlier outside of China, and Japan, we have seen some weakness in construction over the last.
Few months.
Where specifically.
Country Wise, a I think its but it's pretty well dispersed over the the Asia region outside of those two countries and then just remember most of the most of that led to use and those bulk is all basically China and Japan, so that but as a ball come in meat they'd be saw them. All his tend to be relatively small compared to two sutron earned in Japan.
Okay. Thank you and my follow up and Yeah. You've got 130 days have been then targets on hand as at the end of Q3 at where would you expect inventory to end at yearend and is your assumption at this point that end market demand is flat going into next year I mean, what are the downside with that.
Well into next or having to under produce meat cattle are you comfortable that you're not rightsides your own inventories by year end.
Yeah. So again as we look out I mean, they are you talking about CAD inventories will dealer inventories at catalyst I'd tell you can't <unk> hundred 50 days prices on guys 19, new year ago Yep. So the the rise in that obviously there is a lag between actually as we slowed production down ordering components and so forth.
Before it actually flows all through a into day sales, obviously, you also reflecting.
Based on day sales, which are also impacted by things like dealing countries as well. So that has an impact. Some issue are you taking that into account.
But the bigger we are looking obviously inventory, we do know me expects a normal seasonal pattern, which is actually imitrex, reducing Q4, but obviously as we talk at the moment, obviously, we looking at actually reducing a material purchases to reflect the ER. The production declines we've we've spoken about.
But that should rightsizing, so as we're moving to 2020 rudich speech being pretty normal position.
Okay. That's helpful color. Thank you I appreciate it thank you. Thanks.
Your next question is coming from Stanley Elliott from Stifel. Your line is lives.
Hey, good morning, everyone. Thank you all for fitting me in.
Quick question is there anyway to quantify where you'll finish at 2019 in terms of the service sales versus the 2016 2026 targets and then also you've done a nice job of developing a lot of this in house. You is this something that the path will continue forward or is this something that you'll need to look outside of the organization with M&A.
Good morning Stanley what we intend to do is when we announce our fourth quarter results, we will release our.
EMEA and T service sale, so you get a sense of how we're doing it as we talked about at Investor Day, you won't be a straight line up right does it can be impacted by a whole variety of factors in terms of rebuilds and what's going on and we're making investments in.
In digital one other things to answer your question, we utilized outside parties. We are certainly beefing up our internal capabilities as well repeatedly in the area of digital but we're open to M&A. So if seven think about resource allocation to think about how we intend to grow those areas that are most profitable certainly we're open to that.
Well in one of those things we continually evaluate.
Perfect guys. Thank you very much and I look forward seen at first hand, the Conexpo appreciate for before continue there. Thanks Dan.
Your next question is coming from Tim anything from Citi.
Your line is lives.
Thank you and good morning. So the question is on on orders and relative to the guidance that you provided in terms of what you think end user demand and dealer inventories during the fourth quarter I'm curious, how you think orders play into this.
Presumably you'll have maybe a bit less yearend budget flush that than prior years, but I'm just curious to get your thoughts as to how that plays out.
And you know how bus.
In terms of a think about a range in terms of where.
Yearend backlog, Matt Thank you.
Yeah, So as we look out obviously.
If you look where we on backlog at the moment this impacted by number of taxes of one of them. Obviously, probably is a de those expectations have been butchery reductions it depends on way. We in you know obviously the big unknown factor is what is ddas expectations of future gross going to be at the end of the yeah because that.
I will impact their older petting into full.
So it really is a function of that.
As it stands at the moment a you know you would oversee the backlog declined in Q3 reflects a lot of the dealer.
Desire to reduce inventories, which will oversee the point 9 billion.
It depends whether they decide whether they would love to reduce inventories Bourbon 2020, and does that at this point in time, we just don't knows about that that's too early for us until.
Okay, all right. Thanks, a lot.
Your next question is coming from Jerry Revich from Goldman Sachs. Your line is life.
Yes, I get good morning, everyone I'm, Jim I'm wondering if you could talk about what you folks are seeing in terms of the forward looking parts demand indicators for your resource business. A you know as we've seen other useful life assumptions get pushed out by the miners, presumably you you up pretty good visibility on major rebuilds coming up is.
20.
A major inflection and then.
Spoke about the moving pieces and in the market.
Given the economic uncertainty can you just talk about a wind based on the project Awards that you anticipate when do you expect resources will go back to growing the backlog as we hopefully see an acceleration towards more replacement type levels of man.
Good morning, So for resource industries are rebuild activity and parts activity has been strong and we expect that to continue to be strong. So we're not looking for to significantly increase or decrease its been stronger we can think that'll continue.
Yeah, and as far as actually win when do we expect the Uh huh.
Next is putting about what is the timing of any bounce on sort of particularly around pulse lead replacing these really really difficult for us to see when that will happen Jerry to put those particular timeline to it I think obviously based on all the status. We're looking at we do expect suits are happened.
It's just a matter of Tom if that and that really depends on minus views of the outlook and obviously as we said everything appalled from coal is investable. So it's not be investment decision, it's probably better view of the outlook in particular, well just given the history of the last 10 years, you know I believe that miners will continue to be cautious here. So again I think it.
Will be a multi year increase so it'll gradually get better as opposed to probably probably won't see the volatility that we've seen in the past either up or down which pot frankly would be a positive thing for us and the industry. They have it'd be more steady or have a steady increase over several years, then again and volatility we've seen previously.
Okay, and Andrew on the free cash flow numbers at the trough that you spoke about a up analyst day, what level of working capital contribution are you folks embedding I think in prior cycles. It's generally been one they have to $2 billion of positive free cash flow as inventories have come down is that where you're contemplating relative to that.
Trough number yet yeah, so actually the correct. The number supports a six is actually full tight so I actually on those somebody to topping.
But actually what we do I mean, we use similar watching capital assumptions as we've seen in previous cycles, It's actually isn't working capital, which was the main benefit to ER to cash flow. So the lack of restructuring costs is lower capex and also the a the fact, obviously the structural cost we taken out so the include margins bones and three big.
Dr. as all of a good cash flow.
Thank you.
Your next question is coming from make <unk> from Robert W. Baird.
Your line is lives.
Hi, Good morning, Thanks for squeezing me in just a just looking to clarify some earlier comments.
On on the dealer inventory destock so.
You know you're exiting the year with an additional 500 million a of inventory and dealer level year over year. So.
If we're assuming that retail sales are flat in 2020 would that allow you to produce the retail demand or is there additional de stocking that would be need.
So so <unk> I mean, the you know just remind you again dealers, who make those decisions about their inventory levels, it's not us.
Availability, a and all those things can play a part also movie into the day given the lead time for production and the fact that Divas don't want to Miss revenues, they'll make decisions based on that and what expectations or future.
Obviously.
When we looked at it we believe that are the level of dealer inventories within the range or probability that we would expect to become put levels, we talked about three to four months.
And stays in that range, obviously that can be movements within that range, which aren't necessarily within our control. They all divas decisions.
And again, just given the external environment the uncertainty in the in the dynamic environment were and we believe we're well positioned regardless of what happens positive or negative in 2020, we have we shorten our lead times, we have an appropriate level of our dealers have set up an appropriate level of inventory. So we think we're prepared either way.
Okay understood and then my follow up is really on the levers that you have to manager costs as we're seeing some volume fluctuation here I mean, if I'm looking at incentive comp came down modestly from from last quarter as we look going forward, how do you think about.
Any any restructuring or any other actions that you might have to undertake if indeed volumes remain weak or do you feel like at this point you've got enough flexibility.
And your cost structure to be able to handle that without any meaningful month.
So we continually evaluate our cost structure, there's a number of things that we're working on Andrew mentioned, some things that we're doing looking at our or back office costs. If you will also work we have some things the projects that we started there we're looking at material cost that's certainly a big lever for us and that's one of the things that we're working on both direct and indirect.
<unk> costs, we continue to continually looking at ways to become more efficient. So again, we're continually doing that we won't make a call as to whether or not we'll have major restructuring or not again, we'll see what the market brings to us.
Over the next Shimon.
And again either way, we are ready it will be ready to respond.
Thank you okay.
And that's our last question.
Tim.
Well. Thank you for your pre your question to really appreciate your interest will continue to execute our strategy with a focus on services expanded offerings like and operational excellence to deliver long and profitable growth and we'll look forward to chatting with you again next quarter. Thank you.
Thanks, Dan Thanks, Andrew in every line of trying to send the call today before we close at any point outside 16, where we're providing our preliminary 2020, earning eight.
If you have any questions. Please reach out to rather me a you can reach ride at our NGL underscore arrive at Cat Dot Com and then it just go underscored Jennifer at Cat that can I tell me if I remember Farah Investor Relations, it's easier on 96754 or five finite now let me ask Catherine I appreciate it to conclude the call.
Thank you ladies and gentlemen, this does conclude today's conference call. You may disconnect. Your phone lines at the time another wonderful day. Thank you for your participation.
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