Q3 2022 Caterpillar Inc Earnings Call
Welcome to the third quarter 2022 Caterpillar earnings conference call.
Please be advised that today's conference is being recorded.
I'd now like to hand, the conference over to your Speaker today Ryan Fiedler. Thank you. Please go ahead.
Okay.
Thank you and good morning, everyone and welcome to Caterpillar's third quarter of 2022 earnings call I'm, Ryan Fiedler, Vice President of Investor Relations. Joining me today are Jim up will be chairman and CEO , Andrew Bonfield, Chief Financial Officer title athletes Senior Vice President of the Global Finance Services Division.
And Rob Rengel senior IR manager.
During our call today, we'll be discussing the third quarter earnings release, we issued earlier today you can find our slides the news release and a webcast recap at investors that caterpillar dot com under events and presentations.
The contents of this call is protected by U S and international copyright law any rebroadcast retransmission.
Production or distribution of all or part of this content without caterpillar's prior written permission is prohibited.
Moving to slide two.
During our call today, we will make forward looking statements, which are subject to risks and uncertainties. We will also make assumptions that could cause our actual results to be different from the information we're sharing with you on this call.
Please refer to our recent SEC filings and the forward looking statements reminder, in the news release for details on factors that individually or in aggregate could cause our actual results to vary materially from our forecast a detailed discussion of the many factors that we believe may have a material effect on our business on and off.
Ongoing basis is contained in our SEC filings.
On todays call.
We will also refer to non-GAAP numbers for a reconciliation of any non-GAAP numbers to the appropriate U S GAAP numbers.
Please see the appendix of the earnings call slides. In addition, the appendix includes a calendar of expect expected earnings dates in 2023, starting with January 31st for our fourth quarter call.
Today, we reported profit per share of $3 87 for the third quarter of 2022, compared with $2 60, a profit per share in the third quarter of 2021, we're including adjusted profit per share. In addition to our U S. GAAP results are adjusted profit per share was $3 95 for the third quarter of <unk>.
<unk> 22, compared with adjusted profit per share of $2 66 for the third quarter of 2021.
Adjusted profit per share for both quarters, excluding restructuring costs now, let's turn to slide three and turn the call over to our chairman and CEO Jim Ogilvie.
Thanks, Ryan Good morning, everyone. Thank you for joining us.
Close out the third quarter I want to thank our global team for delivering another good quarter, including strong line strong topline growth higher operating profit margins and robust M. E N T pre cash flow despite continuing to supply chain challenges.
Our third quarter results reflected healthy demand across most end markets for our products and services.
We remain focused on executing our strategy and continue to invest for long term profitable growth.
In today's call I'll begin with my perspectives on our performance in the quarter and then I'll provide some insights on our end markets Lastly, I'll provide an update on our sustainability journey.
Turning to slide four overall it was a very strong quarter sales increased 21% in line with our expectations operating profit and proved by 46%.
So the margin improvement of 280 basis points was slightly less than we had anticipated.
The sales growth was led by price realization and volume growth sales were higher in all regions with double digit increases in each of our three primary segments services growth momentum continued in the third quarter as a result of our services initiatives and investments similar to previous quarters. Our top line would have been even.
Higher if not for ongoing supply chain constraints.
We generated strong operating profit margin improvements in the quarter, both on a year over year and sequential basis the.
The adjusted operating profit margin was 16, 5% adjust.
Adjusted profit per share increased 48% to $3 95.
We generated robust M E T free cash flow of $2 $1 billion.
Our backlog continued to grow.
It increased by $1 $6 billion in the quarter and is now $30 billion.
Compared with the third quarter of 2021 sales to users increased 7% for machines, including construction industries and resource industries sales to users increased by 2%, while energy and transportation was up 22%.
Timing of deliveries from dealers to customers resulted in sales to users that were slightly below our expectations.
Sales to users in construction industries were about flat.
North American sales to users were up slightly.
Dealer inventories in North America remained at relatively low levels due to healthy demand and supply chain constraints.
And America experienced higher sales to users well he Amy declined slightly.
As your Pacific sales to users were down in the quarter. However, excluding China sales to users in the Asia Pacific region increased in <unk>.
Resource industries sales to users increased 10% with increases in mining as well as heavy construction and quarry and aggregates.
In energy and transportation sales to users increased by 22%.
Oil and gas sales to users benefited in the third quarter from continued improvement in reciprocating engines.
Turbine and turbine related services were about flat.
Power generation and industrial sales to users remained strong due to favorable market conditions.
Transportation increased from a relatively low base, primarily on strength in marine and international locomotives.
Dealer inventory increased by about $700 million in the third quarter compared to a decrease of about $300 million in the same quarter last year.
Most of the increase relates to timing differences between when we ship products to dealers and when the dealers in turn are able to deliver a completed orders to customers.
Although the ryzen dealer inventory was greater than our expectations inventories remain near the low end of the typical range.
As I mentioned adjusted operating margins improved by 280 basis points to 16, 5%.
Strong price and volume offset increases in manufacturing costs, and SG&A and R&D expenses.
Manufacturing cost increases reflected continued higher material and freight costs and manufacturing inefficiencies caused by supply chain disruptions, resulting in our margins for the quarter being slightly lower than we had anticipated.
Moving to slide five.
We generated $2 $1 billion of M. E&P free cash flow in the quarter, we repurchased $1 $4 billion of stock and returned about $600 million in dividends to shareholders.
We remain proud of our dividend aristocrat status and continue to expect to return substantially all in E&P free cash flow to shareholders over time through dividends and share repurchases.
Now on slide six I will share some high level assumptions on our expectations moving forward.
While we continue to closely monitor global macroeconomic conditions overall demand remains healthy across our segments.
We expect top line growth in the fourth quarter, both year over year and sequentially.
This expected performance reflects healthy demand and favorable price realizations.
We anticipate sales increases across the three primary segments as order levels and backlog remains strong.
As a reminder, dealers have been focused on supplying customer orders and we will look to replenish aging rental fleets over time, when the supply chain situation improves.
We expect adjusted operating profit margins to be significantly higher in the fourth quarter versus the prior year and slightly higher than in the third quarter.
However, we now anticipate that our full year margins will be at the low end or slightly below the low end of the investor day target range.
The headwind is primarily due to ongoing manufacturing inefficiencies related to supply chain constraints ongoing inflationary pressures within manufacturing.
<unk> and our conscious decision to continue to invest for profitable growth.
That said, we expect to achieve our Investor day in E&P free cash flow target range of $4 billion to $8 billion.
Now I'll turn to our outlook for key end markets.
Residential construction generally accounts for about 25% of sales in construction industries, while nonresidential is the remainder.
In North America residential construction is moderating due to tightening financial conditions, but remains at relatively high levels.
We expect nonresidential construction in North America to strengthen supported by the impact of government or government related infrastructure investments.
In Asia Pacific, Excluding China, we expect moderate growth due to higher infrastructure spending and commodity prices.
As we mentioned last quarter weakness continues in China, and the excavator industry above 10 tons.
It is expected to remain below the 2019 levels due to low construction activity.
Any Amy business activity is expected to be flat to slightly down versus last year based on uncertain economic conditions in Europe . However.
However, strong backlogs and announced infrastructure plans limit the decline.
Construction activity in Latin America is expected to grow due to supportive commodity prices.
In resource industries, our mining customers continue to exhibit capital discipline. However, commodity prices remains supportive of continued investment despite trending lower recently.
We expect production and utilization levels will remain elevated and our autonomous solutions continues to gain momentum.
I'll highlight an example in a moment.
We expect the continuation of high equipment utilization and a low level of parked trucks, which both support future demand for our equipment and services.
We continue to believe the energy transition will support increased commodity demand expanded our total addressable market and providing opportunities for profitable growth.
Heavy construction and quarry and aggregates, we anticipate continued growth in the fourth quarter.
In energy and transportation, we expect continued sales momentum in the fourth quarter due to strong order rates in most applications.
The oil and gas although customers remain disciplined we are encouraged by continued strength in our reciprocating engine orders, especially for large engine re powers as asset utilization increases.
New equipment orders for solar turbines have strengthened significantly, particularly in oil and gas, indicating sales growth in late 2022 and 2023.
So all of our services revenue is expected to remain steady.
We expect a strong fourth quarter, which is typical of our which is typically our highest sales quarter of the year for solar.
Power generation orders remain healthy due to positive industry dynamics and continued data center strength Inge.
Industrial remains healthy with continued momentum in construction agriculture and electric power.
In rail North American locomotive sales are expected to remain muted.
We also anticipate growth in high speed marine as customers continue to upgrade aging fleets.
Moving to slide seven as we continue to advance our sustainability journey through the third quarter of 2020 to Caterpillar cat dealers and our customers announced a number of projects that will help contribute to a lower carbon future.
I'll highlight two today.
In late August we announced a significant step in this journey when BHP Group limited Caterpillar and Finning International announced an agreement to replace Bhp's entire haul truck fleet at the Escondida mine in Chile, the world's largest copper producing mine.
We will replace one of the industry's largest mixed fleets.
Currently comprised of over 160 haul trucks with new Caterpillar 798 AC electric drive haul trucks deliveries began in 2023 and will extend over 10 years, the new electric drive trucks will feature technology that deliver significant improvements in material moving capacity efficiency reliability.
And safety.
The agreements allow BHP to accelerate the implementation of its autonomy plans by transitioning the fleet to include technology that enables autonomous operation.
In addition, the agreement set forth a path for BHP to meet its decarbonization goals through the progressive implementation of zero emission trucks.
Second we're currently displaying for.
For battery electric machine prototypes knit bomber in Munich, Germany, including many in medium excavators and <unk>.
C medium wheel loader and a compact wheel loader. Each machine is powered by Caterpillar battery prototypes and includes onboard AC Chargers. We also plan to offer an off board DC fast charging option.
Leveraging our deep system integration experience the batteries are scalable to industry and customer performance needs and maximize sustainability throughout their lifecycle, including recycling and reuse at the end of life.
The caterpillar designed batteries in these machines will also be available to power other industrial applications, highlighting our ability to leverage technology across the enterprise.
With that I'll turn the call over to Andrew.
Thank you Jim and good morning, everyone.
I'll start by walking you through our third quarter results, including the performance of our segments.
Then I'll discuss the balance sheets, and <unk> free cash flow before concluding as usual with our expectations for the fourth quarter and full year.
Beginning on slide eight sales and revenues for the third quarter increased by 21% or $3 6 billion to $15 billion.
The increase was due to strong price realization and volume, partially offset by currency impacts.
Operating profit increased by 46% or $761 million to $2 $4 billion as price realization and volume growth were partially offset by higher manufacturing and SG&A and R&D costs.
Our adjusted operating profit margin of 16, 5% increased by 290 basis points versus the prior year's quarter as the impact of price realization and volume growth outpace continued manufacturing cost increases.
Adjusted profit per share increased by 48% to $3 95 in the third quarter compared to $2.66 last year.
Adjusted profit per share for both quarters, excluding restructuring costs, which were <unk> <unk> per share this quarter compared to <unk> in the prior year.
In total taxes benefits profit per share by about <unk> <unk> per share for the quarter.
During the third quarter of 2022, we reached a settlement with the U S. Internal revenue service the resolves all issues for taxes 2007 through 2016.
We are pleased to have settled the audits without any penalties and within our reserves.
The settlement includes amongst other issues the resolution of disputed tax treatment of profits earned by Caterpillar S. A R L from certain parts transactions.
The final tax assessed by the IRS for all issues under the settlement was $419 million for the 10 year period.
460 million $7 million of this was paid in the third quarter of 2022 and the associated estimated interest of $250 million is expected to be paid by the end of the year.
The settlement was within reserves in the company recorded a discrete tax benefit of $41 billion to reflect changes in estimates of prior year taxes and related interest net of tax.
Yeah.
Now on slide nine.
<unk> increased by 21% on strong price realization and volume while currency was a headwind given the strong U S dollar.
Overall sales were about as we expected.
Regarding volume the largest benefit versus the prior year was a $1 billion favorable quarter over quarter change in dealer inventory.
Sales to users increased by 7%.
While there is continued uncertainty regarding the macroeconomic backdrop backdrop demand indicators remain supportive of sales to users increased by 7% backlog grew by $1 $6 billion to $30 billion and dealer inventory remains at the low end of the typical range.
As we've seen in recent quarters the dealer inventory increase was primarily due to issues, resulting from the timing of deliveries from dealers customers and delays in the commissioning machines as a result of labor shortages at dealers.
Yeah.
The net impact was the sales to users was slightly lower than expected.
Corresponding offset an increase in dealer inventories.
As both Jim and I have indicated we believe that the majority of this is timing and is not an indicator of changing market dynamics.
Inventories remained at the low end of the typical range.
Yeah.
Moving to slide 10.
As I mentioned third quarter operating profit increased by 46% on favorable price realization and volume.
Price realization was in line with our expectations and was supported by healthy demand.
Manufacturing costs continued to increase versus the prior year, primarily due to material and freight cost increases as well as manufacturing inefficiencies due to supply chain constraints.
Overall, the impact of favorable price realization exceeded manufacturing costs for the quarter.
Finally, SG&A and R&D costs increased primarily due to investments aligned with our strategy for profitable growth.
Services growth in technology, such as digital electrification and autonomy.
Our third quarter adjusted operating profit margin of 16, 5% was at 290 basis.
Points increase versus the prior year.
The impacts of price actions accelerator, so price realization was strong.
Although we began to lap the significant increases in material and freight costs seen in the second half of last year, we are still seeing cost increases from suppliers for materials in particular.
Finally related to our recent price cost performance keep in mind that we are still catching up from the increases in manufacturing costs, which have occurred over the last three years.
In particular, the material and freight costs have increased by about 20% since 2020.
Our gross margin of 28, 5% for the third quarter is now only just getting back in line with the levels seen in the third quarter of 2019, despite sales and revenues being higher.
Moving to slide 11 as.
As we expected segment sales and margins improved in the third quarter.
Starting with construction industries sales increased by 19% to $6 3 billion.
Driven by favorable price realization and sales volume, partially offset by currency.
Volume increased primarily due to changes in dealer inventories, which increased in the quarter compared to a reduction last year.
Sales in North America rose by 29%, Judy due mostly to strong pricing and a favorable change in dealer inventory.
Dealers in North America decreased the inventories in the third quarter of last year was we saw some build this year.
North American dealer inventory is still very low which impacts our ability to supply the region.
Sales in Latin America increased by 51% on strong price realization.
As of equipment to end users and a favorable impact due to changes in dealer inventories.
In both EMEA and Asia Pacific sales were relatively flat as strong price realization was offset by currency.
Third quarter profit for construction industries increased by 40% to $1 2 billion versus the prior year.
Price realization and higher sales volume drove the increase as price more than offset manufacturing costs.
Unfavorable manufacturing costs, largely reflected higher material and freight costs. In addition to manufacturing inefficiencies.
The segment's operating margin of 19, 3% was an increase of 290 basis points versus last year.
Turning to slide 12 resource industries sales grew by 30% in the third quarter to $3 1 billion.
The improvement was primarily due to favorable price realization and higher sales volume.
Volume increased due to the impacts of changes in dealer inventories higher sales of Boston market costs and higher sales of equipment to end users.
Third quarter profit for resource industries increased by 81% to $506 million.
As price realization more than offset manufacturing costs, which largely reflected higher material freight and manufacturing inefficiencies.
The segment's operating margin of 16, 4% with an increase of 460 basis points versus last year.
Now on slide 13.
Energy and transportation sales increased by 22% to $6 2 billion.
With sales up across all applications.
Oil and gas sales increased by 22% due to higher sales of reciprocating engine after market parts and engines used in well servicing applications and gas compression.
Power generation sales increased by 31% sales increase for both turbines and reciprocating engines as data center activity remained strong.
Industrial sales rose by 22% with strength across all regions.
Finally transportation sales increased by 9% on reciprocating engine after market parts and relative strength in marine applications.
International locomotive deliveries also benefited sales.
Okay.
Third quarter profit for energy <unk> transportation increased by 32% to $935 million.
The improvement was primarily due to favorable price realization and higher sales volume, partially offset by higher manufacturing and SG&A and R&D costs.
As anticipated price realization narrowly offset manufacturing cost.
Manufacturing cost increases largely reflected higher material and freight costs, coupled with manufacturing inefficiencies.
Also SG&A and R&D expenses increased due to investments aligned with our strategic initiatives, including electrification and services growth. In addition to higher short term incentive compensation expense.
The segment's operating margin of 15, 1% was an increase of 120 basis points versus last year.
Moving on to slide 14.
Financial products revenue increased by 7% to $819 million benefiting from higher average financing rates in North America, and Latin America.
Segment profit increased by 27% to $220 million.
The profit increase was mainly due to a favorable impact from a lower provision for credit losses at cat financial.
Moving to our credit portfolio, a leading indicators remain strong.
<unk> a good proxy for the financial health of our customers with 2.00% compared with $2 four 1% at the end of the third quarter of 'twenty to 'twenty one.
We also saw a 19 basis 19 basis points decrease in post use compared to the second quarter of this year.
Retail new business volume did decline compared to the record levels in the prior year.
However, at this point cat financial is not seeing slowing business activity, but is instead impacted by strengthening competition from banks.
This is typical in a rising interest rate environment as banks benefit from a lower cost of funds, especially due to customer deposits.
Finally used equipment demand remained strong as elevated prices have stabilized and inventories remain low.
Now on slide 15, <unk> free cash flow in the quarter increased by about $1 2 billion versus the prior year to $2 1 billion.
The increase was primarily due to higher profit and favorable net working capital.
We did continue to build production inventory to support shipments and mitigate component delivery delays and increase of about $1 billion versus the second quarter.
Cumulatively <unk> free cash flow year to date is $3 8 billion. Despite the increase in inventories and the payment of incentive compensation in the first quarter of 2022.
Looking ahead, we continue to expect to achieve our investor day in E&P free cash flow target of between four and $8 billion for the full year.
As Jim mentioned, we paid around $600 million in dividends. In addition to repurchasing about $1 4 billion worth of common stock.
Putting our objective to be in the market on a more consistent basis.
Enterprise cash was $6 $3 billion about a $300 million increase compared to the second quarter 2022.
The increase was primarily driven by higher free cash flow.
Our liquidity remains strong as we continued to hold some of our cash balances and slightly longer dated liquid marketable securities and also improves the liquidity has improved the yield on that cash.
Now on slide 16, I will share some thoughts on the fourth quarter and the full year.
As a reminder, the third quarter was generally in line with our expectations on the top line and while our margins were better than the prior year that were marginally lower than we had anticipated.
Pricing gain momentum against the backdrop of stronger demand, while manufacturing costs increase on continued inflationary cost headwinds for our suppliers and manufacturing inefficiencies due to the ongoing disruption to the supply chain.
We also continued to invest for future profitable growth.
Looking ahead, we anticipate the fourth quarter will reflect our highest quarterly sales for the year, which is in line with typical seasonality.
Compared to the prior year higher sales to users on price realization should support the topline growth.
At year end, we expect dealer inventories to remain at similar levels as they ended in the third quarter.
We also expect sales increases across the three primary segments, both year over year and sequentially.
Infrastructure spending should continue to benefit our segments overtime as nonresidential building buildings accelerates and large projects commence.
On margins, we should see slightly higher adjusted operating margins in the fourth quarter compared to the third on higher volume and continued pricing momentum.
We do anticipate the manufacturing cost increases, including manufacturing inefficiencies will act as a partial offset.
At the segment level, we expect to see similar margins to the strong third quarter performance in construction industries.
In resource industries, and energy and transportation margins should strengthen compared to the third quarter and prior year.
Compared to last year, all three primary segments should benefit from price realization and higher volumes.
We expect price realization to more than offset manufacturing cost across our three primary segments in the fourth quarter.
Finally to assist you with your modeling we continue to expect our accrual for short term incentive compensation expense of about $1 $6 billion a share.
Capex is expected to be about $1 4 billion.
We anticipate the global effective tax rates of around 23% slightly lower than previously expected due to changes in the geographic mix of profits from a tax perspective.
Finally restructuring charges are expected to be up up to $800 million for the full year.
There is a possibility that the largest auction, which is a noncash charge of approximately $600 million.
Relating to digest divestiture may slip into 2023.
So turning to slide 17, let me summarize.
Sales grew by 21% led by strong price realization and volume gains across all the segments.
The adjusted operating profit margin increased by about 280 basis points to 16, 5%.
Yeah.
<unk> free cash flow was strong at $2 1 billion and.
And we continued to return cash to shareholders on a consistent basis.
The outlook remains positive with sales to users up 7% and the backlog up $1 $6 billion to $30 billion.
We continue to execute our strategy for long term profitable growth.
And with that we'll take your questions.
As a reminder, management asks that you limit your you limit to one question per analyst.
Vacation is desired please rejoin the queue.
Your first question comes from the line of Rob Wertheimer with Melius Research. Your line is now open.
Thanks, and good morning, everybody.
I'm wondering if Tony Robinson is going to be.
My question is about price and competition and I guess future market share your prices extremely stronger margins will come back strong with it.
From the outside backlog looks very very good as the orders and I'm. Just curious if you can see your competition following your price increases.
Our general market share trends are down if you could give any comment on where you think the balance will be thank you.
Thanks, Rob for your question you were always focused on remaining competitive in the markets that we serve around the world and we certainly factored that into all pricing decisions. It's not a one size fits all situations, we do pay attention to the different dynamics in different markets we serve.
We are comfortable with our competitive position.
Again, it's always something that we focus on so.
Yes.
Okay.
Your next question comes from the line of Stephen Volkmann with Jefferies. Your line is now open.
Great. Thank you and good morning, everybody good.
Good morning, let me see.
My question is on the cost side and Andrew I think you mentioned a couple of times that of Euro of $1 1 billion increase in manufacturing costs. Some portion of that was related to.
Unfavorable productivity from all of the supply chain issues and I'm wondering if you can maybe ballpark kind of how much of that would be and is there any reason not to think that productivity just sort of gets better and normalizes once supply chains are normal.
Yes, Steve.
As I indicated.
Effectively manufacturing costs was slightly adverse to our expectations that was why margins overall came in slightly lower than we had anticipated most of that is June and it is relatively small.
But as a result of manufacturing inefficiencies.
We don't break down manufacturing costs for number of reasons. They do vary in all the buckets do vary quarter on quarter, but you are absolutely correct. Once we get past the supply chain bottlenecks, we do believe basin and inefficiencies will normalize for example, they may be including things like additional labor in the factories, which are there to help <unk>.
Port of a process work as we keep continuing to make sure we get machines out as quickly as possible that will normalize when supply chain that can change on normal. So we will expect that to moderate over time as we go forward.
Yeah.
Thank you.
Yeah.
Your next question comes from the line of David Raso with Evercore. Your line is now open.
Hi, David Hi, David I'll, let you answer this sort of open ended question. However, you choose.
I mean, it looks like if you get normal seasonality third third quarter to fourth quarter on your revenues sort of the way you're discussing the margins.
You're pretty close to $4 a share.
For the quarter and I know fourth quarter is usually a little higher than the average quarter, but given what youre seeing in the backlog year end market commentary.
Prior discussion about price cost and so forth what are the things that we should think about to not look at that $4 number as a bit of a run rate.
Going into 2023 for quarterly earnings power.
Okay.
Yes, yes, David of course as you can imagine here in this call you know, we're not going to talk about 2023, and what our expectations are for <unk>.
For profit.
But again, we are pleased that the way that the team performed in the year and we talked about the fact that we still have supply chain struggles that we're dealing with but we also have strong demand across most of our end markets and David as we've consistently said this year. It is an unusual year from a shape of earnings.
<unk> because normally as you know we start the year very strong from a margin perspective, our margins move downwards as we go through the year.
This year that is actually inverting the other way.
So obviously that is a part of that which will have to come back to when we talk about 2023, how the shape of that yield look as a result of those those changes in market dynamics. So.
And I'll remind you that obviously the fourth quarter is our highest normally our highest quarter from a revenues perspective, that's consistently been.
The way for Caterpillar.
Yes.
Your next question comes from the line of Jamie Cook with Credit Suisse. Your line is now open.
Hi, good morning.
Morning, Jamie.
Sorry.
I'll touch on 2023, again, but I'm just trying to think through as well and you think about Hoffman's question on inefficiencies gone away and we're asked this question on the you know for $4 per quarter run rate I guess, the other thing as we think about 2023 dealer inventories are still exceptionally low in the rental fleet is also AIDS in Alex.
As you look at 2023, assuming the macro holds where do you expect to.
Rental fleet.
Which would also sort of be additive to 2023. Thank you.
Yes, so much depends Jamie of course on what happens with the supply chain and as you mentioned what happens with demand as well.
If in fact, the supply chain situation improves and we're not making a prediction at this point we've started to see some pockets of of improvements in other areas remain very challenged but if in fact.
Supply chain situation improves one would expect dealers would try to get their inventories, including rental fleets up to a more typical level.
But again so much depends upon.
The two big variables Aero supply chain and of course, what happens in the end markets in terms of demand.
Okay. Thank you.
Yeah.
Okay.
Your next question comes from the line of Michael Feniger with Bank of America.
Your line is now open.
Hi, Michael.
Hey, Good morning, you have highlighted for some time the growth in resources.
Even when customers are constraining their mining capex budgets and being disciplined there I'm curious Jim how you see that evolving with energy capex budgets, when we dig into that oil and gas and energy side. There are some signs that rig counts flattening discussion of more disciplined capex just within.
In your energy portfolio, what do you see the most strength in that backdrop as we go into 2023. Thank you.
Well certainly as we mentioned, we do see our customers displaying capital discipline. However, we do see as I mentioned in my prepared remarks, a lot of strength in the oil and gas reciprocating engines as an area of strength.
Solar turbines their order rates have.
Have improved.
Quite quite substantially which should help us in 2023, so one of things to keep in mind of course is that customers need to maintain oil and oil and gas production.
To maintain a certain level of production requires continued investment and to just to maintain a flat level of production and so again.
We are we are certainly encouraged by the signs that we see in terms of the order rates that are coming in based on the conversations we're having with customers we feel good about about our prospects there.
Okay.
Hi, Tim Hi, Tim Hi, Good morning, Thanks, just maybe another one on back on the manufacturing cost and again I get it.
Yes.
Great.
Especially on the freight side, we've seen more real time, some fairly significant declines there.
Especially on the freight side and when that potentially against the impacts of cat. Thank you.
Yes.
Actually the biggest single factor that we all focus on rather than actually just pricing and Friday at the moment is actually utilization of freight because one of the challenges has been actually the amount of freight we've had to use in order to get components around taxi build machines, that's been probably the bigger driver of some of the increase that we've seen.
For example, the roll on roll off will actually favorable to the current market, but obviously container freight is coming down as well. So we're seeing some favorability on that in the spot markets. Obviously, you will expect some of that to flow through.
As we move into 2023.
How good the results were versus.
Get you to the targeted levels I guess based on the 23 list prices that you folks have in place it feels like.
Pricing should be accelerating further into the first quarter. So I'm wondering does that get you to where you want to be.
Well. Thanks for your question, you're one of the things to keep in mind is that our margin targets of progressive which means that we need to achieve higher operating margins as sales increase.
And you know in a moderate inflationary environment, which we saw for many years sales increases typically are led by higher volumes and the benefit of the operating leverage associated with those higher volumes helped us achieve our progressive margins in the environment that we're in today, where a relatively larger portion of the sales increase is due to price.
Realization theres less operating leverage which makes the delivery of those progressive margins more challenging to achieve so part of it is just a math issue in terms of where the sales increase comes from is it primarily volume or is it primarily price and the impact on operating leverage.
Having said that you know our focus is closing out the year as strongly as possible in the fourth quarter, but that's really the issue. It's the issue around just the math.
And the assumptions that we made around our margin targets when we when we set them.
Okay. Thanks.
You bet.
Your next question comes from the line of Stanley Elliott with Stifel. Your line is now open.
Good morning, everyone and thank you all for the question.
Quick question, you mentioned the supply chain gets a little bit better you start to see the dealer inventory piece.
Square back up a little bit into next year.
Even if we do get a supply chain improvement will you still be below kind of what would be normal historical levels at the dealer inventory just curious how to think about that thanks.
Yes, it really it really depends on the specifics of what happens to demand what happens to how much does the supply chain.
There is really so many variables there.
It's difficult to predict.
Again.
As we look at our dealer increase we just had dealer inventory because you just had most of the increases relate to timing differences between when we ship product to dealers and when they actually complete orders to customers.
Again, we look forward to next year it depends on demand it depends on how much the supply chain eases and a number of other issues and just to remind you that dealers are independent businesses. So they make their own decisions about dealer inventories and that's something we can control.
So they will actually build it based on what they expand their expectations of the outlet business as well.
Great guys. Thanks.
Your next question comes from the line of Chad Dillard with Bernstein. Your line is now open.
Hi, Chad.
Hi, good morning, guys.
So I have actually a bit of a longer term question just going back to your 160 truck win with BHP and come to your mind just trying understand is like how does electrification change your gross profit tan across those vehicles versus internal combustion is trying to think through the puts and takes.
As those deliveries start to trickle through in the second half of next year.
Yes, so the profitability around.
Diesel engine versus batteries as a lot of puts and takes there and again, we're still working our way through what our services model would be in all that we are excited about the opportunities that exist in one of the things that we believe positions us very well as the fact that we have in energy and transportation segment, which allows us to have additional opportunities with our mining customers to <unk>.
Getting the site ready so.
Just to resolve any confusion.
Trucks that we start shipping next year for that mine will not be 100% battery trucks. So I think that was inherent in your question. So there are diesel electric trucks.
Just to clarify that so I think you may have misunderstood in my statement.
Thank you.
Keith.
Your next question comes from the line of Steven Fisher with UBS. Your line is now open.
Thank you good morning.
Good morning.
Given the lingering manufacturing inefficiencies that you are still experiencing I'm curious how you're planning process for 2023 is comparing or is going to compare to your process for 2022 really thinking about the supply chain and you've had another year of lessons learned I am curious what you think you.
Can do differently for 2023 to further enhance your production capacity and flow.
We're working closely with our suppliers and as I think all companies are doing thinking about.
Our supply chain and certainly resilience is very important and of course, given the capital intensive nature of our business and our suppliers. It isn't easily to make changes quickly, but we are working closely with our suppliers trying to ensure that we have second sources in as many cases.
Most instances.
We're doing things in our factories as well to really try to anticipate issues that are happening. There is no single magic magic button that we can push to make these issues go away, but again it really comes down to our teams in our factories are working to be creative to find ways to mitigate disruptions and again working with our suppliers to try to get as much supply as we can.
Yet.
And then from a planning side, obviously you one of the things. We do is we do various scenarios and obviously, yes, we do look at what's happened looking at that tried to then work through what the implications of that would be.
On production levels, and how we would manage through that and then obviously trying to build in at the same time demand signals. So it's a very dynamic process.
It's one of the most large companies as you would imagine go through the complexity for US is just scope and size and.
On scale of Caterpillar and that obviously, you've got running this through 100 accounts and so forth. So it is a lot of work and people who are working very hard as we speak getting ready through 'twenty.
'twenty three planning cycle.
Thank you.
Your next question comes from the line of Kristen Owen with Oppenheimer. Your line is now open.
Good morning Kristen.
Great question.
I wanted to come back to you.
To your comment about the backlog offsetting maybe a weaker economy.
Thank you.
Thank you.
Industrial activity.
Im wondering if theres any sort of commentary you can provide escalating that youre seeing at <unk>.
<unk> media deployment.
The investment.
Our energy asset hardening any commentary you can provide that would be helpful.
If we step back and think about it from a global macro perspective.
Certainly the increased investment in oil and gas benefits our business and.
Yes.
And thats and Thats being driven by whole variety of issues.
Situation in Europe is only one of them, but as an example.
If in fact the U S.
To export more LNG as an example, caterpillar participates across a wide portion of that natural gas value chain, where engines are used for drilling our engines, our recip engines drive reshaped compressor.
Compressors for gas gathering.
We're very involved at the well servicing side now with our acquisition from where oil and gas you can always play a larger portion there are shoulder gas turbines driving our solar strictly natural gas compressors compressed gas down the pipelines. So as an example, there is a drive for more LNG again that that would benefit our business.
Again, a lot of it's there are a lot of factors there that are driving of course, the dynamics in the oil and gas business, but our participation. There again I believe stands to benefit from just the increased investment that most believe will happen over the next two.
Two years.
Then just always as a reminder, any move to further renewables as benefits us and particularly in that mining business again.
As a result of the increased need for commodities in order to help with that transition so ultimately that that.
That does have a benefit chose the other thing just to remind you as theyre all some infrastructure initiatives in Europe withdraws, obviously, helping to keep some.
Some level of demand going obviously.
Macro is obviously as you know and as we spoke a little bit negative, but obviously those offsetting.
Benefits for US Yes. Great example is the <unk> project in the UK, where a lot of caterpillar equipments being used so infrastructure in Europe is important a lot of that of course is government support.
Yeah.
Thank you.
Okay.
Okay.
Hello are you there.
Okay.
Your next question comes from the line of Matt Alcott with Cowen. Your line is now open.
Good morning, everyone.
Hello, if I may I take it back to North America I know you guys have touched on the unfavorable trend in residential construction in recent quarters.
But I'd love to hear your thoughts on how the current housing downturn field relative to prior housing downturn downturn from your perspective and in other words the impact the impact you've seen so far on your equipment business. This year relative to a similar point of the housing cycle downturn.
I know, that's probably not super easy to gauge, but any thoughts would be helpful. Yes, it's difficult to make a comparison to prior.
Prior situations, but.
Of course, we've been in a situation where the demand for our products that support.
Residential housing has been very strong so.
Had very high order levels, we have talked about some.
Some softening there, but one of the things to keep in mind is of course that that that residential only represents about 25% of Ci sales and the rest is nonresidential and nonresidential remains more resilient.
Hope for a whole variety of subjects that certainly there are more resilient to rate increases just to do capital planning cycles.
Think about all the investments that are being made by governments around infrastructure, so that helps as well.
Honestly.
I don't have a good answer for your question in terms of how this compares to previous slowing in residential.
Again, there is.
Theres lots of predictions as to how that will play it over the next few years, but but again.
Demand for our products in Ci at a macro level still remains quite robust.
Great. Thank you very much.
Your next question comes from the line of Larry de Maria with William Blair. Your line is now open.
Thanks, Good morning.
As it relates to that relates to the prospects coming recession.
<unk> seen any concerns out there yet aside from a residential obviously overall orders are pretty strong.
And are you doing anything to prepare enough one or is it more or less a wait and see considering the backlog is strong and has low inventory.
But certainly we continue to closely monitor the global macro economic environment.
Part of our the strategy, we laid out in 2017 was a competitive and flexible cost structure. So we've demonstrated the ability to take action when we need to take action, having said that as we sit here today, we continue to see healthy demand across most of our end markets. We have strong orders our dealer inventory remains towards the low end of the typical.
Range.
So again.
We have demonstrated the ability to have a flexible cost structure indirect quickly when we need to think about 2020 in a year when when COVID-19 hit and we had a pandemic induced.
Significant decline in our sales, we still met our margin targets that year. So again.
We know what to do but as we sit here today, even though we're watching things very closely we continue to see healthy demand across most of our end markets.
Thank you.
Your next question comes from the line of John Joyner with BMO capital markets. Your line is now open.
Hey, good morning, Thank you for taking my question.
So.
I hate to pile on the manufacturing inefficiencies, but I guess, how would you characterize the constraints today versus say.
Six months ago, a year ago, a year ago or earlier. This year was a 10 with 10 being the worst what would it be today and I'm just trying to gauge.
How much things have improved or not.
And maybe are there any areas that that might not ever quote normalize.
Yes, I wouldn't say that there arent areas that will normalize.
It's a mixed bag.
So in certain areas, we still have a real.
A real challenges.
And to get the supply chain certain areas have gotten a bit better but in terms of manufacturing inefficiencies if anything they've gotten a bit worse as opposed to getting better in the last quarter.
In terms of values. They are higher now than they were in Q2 and Q1.
And obviously that is something we're monitoring and keeping a very close eye on most of the manufacturing inefficiencies as not just how the process work it is actually labor related.
And part of that is obviously in an environment, where we still see strong demand signals you don't want to.
Even though your labor may be slightly higher than you would need for the level of production. You've got you will actually keep those people working in the plants because it's principally to do so that is the main causes.
You can see that we're seeing today.
Okay. That's helpful. Thank you thank.
Thank you.
Your next question comes from the line of Seth Weber with Wells Fargo. Your line is now open.
Hey, good morning, everybody good morning.
Just wanted to follow up on that last question.
There's been a lot of questions and answers about the supply chain, but can you just maybe share what your partners are telling you.
About 2023, I understand you may want to handicap, what they are telling you but are they directionally.
Telling you things are going to get better or is it a first half second half are you getting any indications from the supply chain that things should be.
Moving in the right direction for next year.
Honestly it is it is a mixed bag.
Caterpillar is you know has a very diverse product line and we have a very diverse group of suppliers.
Suppliers around the world and there isn't one answer there so we.
We continue to see.
Semiconductor availability challenges, you're impacting things like engine control modules, which having an impact on many of our products. So that's still a challenge even though certainly we follow what happens in the semiconductor industry and we brought about some of the improvements for the ones that we use and again those that go into it to Etfs, that's still a bit of a challenge.
<unk>.
My sense is that so.
Many suppliers that are struggling now are quite reluctant to make any kind of predictions because many people have made predictions since we've gone into this situation that have proved to be wrong about improvement. So again, what we're doing is working with them as closely as we can to help them get as much supply out as they can and as we mentioned earlier to try to mitigate the impact.
Those shortages in our factories and that's really our focus.
Hi.
Yes.
Yes.
As Ryan we've got time for one more question.
Excellent. Today's final question comes from the line of Tami Zakaria with Jpmorgan. Your line is now open.
Good morning, guys, Hi, Hi, how are you. Thank you for taking my question.
So based on the order they are taking and the backlog is clearing any comments on what pricing may look like next year, because it seems like youre going to get double digit pricing. This year. This should double digit pricing sustained at least through the first half of next year as we burn through that backlog.
Yeah. So again, you know as we as we think about any any pricing actions for next year. Obviously, we always are focused on maintaining our competitive position in the market can we think about that in terms of any future pricing decisions.
<unk> the run rate, obviously, just so hot.
Highlight we're not talking about 2023, yet, but just thinking about the fourth quarter, we are actually.
Lapping some price increases that we saw in the.
In the third quarter of.
Fourth quarter of last year, So we will see slight moderation of price in the fourth quarter still very strong obviously that will help us as we move into 2023, but obviously as Jim said, we're not yet and so that situation, where we have a plan that we can give you and obviously competitive positioning is obviously critical as part of that.
Okay.
With that I just want to thank you.
You bet. Thank you and thanks all of you for your questions.
Just don't want it one more time, thank our global team for performing very well in a challenging environment, increasing sales by 21%.
We mentioned our backlog in sales to users increased which are positive demand indicators. As we look ahead adjusted operating profit margins improved by 280 basis points, we expect a strong fourth quarter with sales and margin improvement. In addition to continued strong cash flow and of course, we remain focused on executing our strategy for long term profitable growth again, thanks to all of you.
Great. Thank you, Jim Andrew and everyone, who joined US today, a replay of our call will be available online. Later. This morning, we'll also post the transcript on our Investor Relations website as soon as it's available you'll also find a third quarter results video with our CFO and an SEC filing with our sales to users data.
Click on investors Dot Caterpillar Dot com and then click on financials to view those materials. If you have any questions. Please reach out to Robert <unk>.
Investor Relations General phone number is 390 675 for $5 49, we hope you enjoy the rest of your day and now I'll turn it back to Emma.
On the call.
This concludes today's conference call. Thank you for attending you may now disconnect.
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