Q1 2023 Caterpillar Inc Earnings Call
Welcome to the first quarter 2023, Caterpillar earnings conference call.
Please be advised that today's conference is being recorded.
I would now like to hand, the conference over to your speaker today, Brian Fiedler.
Please go ahead.
Okay.
Thanks, and good morning, everyone and welcome to Caterpillar first quarter of 2023 earnings call I'm, Ryan Fiedler, Vice President of Investor Relations. Joining me today are Jim <unk>, Chairman and CEO , Andrew Bonfield, Chief Financial Officer, Kyle Appellees Senior Vice President of the Global Finance Services Division.
And Rob Rengel senior IR manager.
During our call today, we will be discussing the first quarter earnings release that we issued earlier today you can find our slides the news release and a webcast recap at investors day at Caterpillar Dot com under events and presentations.
Contents of this call is protected by U S and international copyright law, any rebroadcast retransmission reproduction or distribution of all or part of the 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 may differ from the information we're sharing with you on this call. Please.
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 an ongoing base.
This is contained in our SEC filings on today's call 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 now, let's turn to slide three and turn the call over to our chairman and CEO Jim Applebee.
Thanks, Brian Good morning, everyone. Thank you for joining us I'd like to start by thanking our global team for a strong first quarter, including double digit topline growth higher operating profit margins record adjusted profit per share and a strong M E&P free cash flow.
Our results reflect healthy customer 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.
Today's call I'll begin with my perspectives on our performance in the quarter.
Then provide some insights on our end markets.
Lastly, I'll provide an update on our sustainability journey.
It was a very strong quarter sales and revenues were better than we expected with price realization dealer inventory and sales to users each slightly better than we anticipated say.
Sales to users were higher than expected in energy and transportation and resource industries overall.
Overall sales and revenues rose by 17% versus the first quarter of 2022.
Year over year increase was due to strong price realization and volume growth, which was driven by higher sales of equipment to end users.
We achieved double digit top line increases in each of our three primary segments.
Adjusted operating profit margins increased to 21, 1% in the first quarter as we saw margins improve both on a sequential and year over year basis.
The adjusted operating profit margins were significantly better than we had anticipated primarily due to better than expected manufacturing costs, including efficiencies and absorption stronger price realization and volume growth.
Andrew will discuss in detail later.
Backlog ended the quarter at $34 billion flat relative to the fourth quarter of 2022.
Equipment availability increased during the quarter due to improving supply chain conditions.
The dealer order rates are lower they remain at healthy levels. As you know is availability improves order rates typically normalize as dealers can wait longer to place orders for long lead time items.
Our healthy backlog continues to underpin our constructive views about our end markets.
Despite the improvement in supply chain pockets of challenge remain as we increase production, particularly for large engines, which impacts energy and transportation and some of our larger machines.
We delivered a strong first quarter, which positions us well for an even better year in 2023 than we previously anticipated.
While we continue to closely monitor global macroeconomic conditions overall demand remains healthy across our products and services.
Turning to slide four in the first quarter of 2023 sales and revenues increased 17% versus last year to $15 $9 billion. This was primarily due to favorable price and volume growth compared.
Compared with the first quarter of 2022 overall sales to users increased 13%.
For construction industries and resource industries sales to users rose by 5%, while energy and transportation was up 39%.
Sales to users in construction industries were flat in line with our expectations.
North American sales to users increased as demand remained healthy for both nonresidential and residential despite some moderation of the growth rate in residential.
Overall, our north American sales to users were better than we expected.
Amy also saw higher sales to users led by strength in the middle East.
In Latin America, and Asia Pacific sales to users declined in the quarter <unk>.
Decline in Asia Pacific included further weakening in China.
In resource industries sales to users increased 18%, which was our third consecutive quarter of accelerating sales to users.
In mining sales to users benefited from a higher level of commissioning in the quarter.
Within heavy construction and quarry and aggregates sales to users also increased supported by growth for infrastructure related projects.
In energy and transportation sales to users increased by 39% in the first quarter oil and gas sales to users benefited from continued strength in new engine sales to customers, including Repowering active fleets upgrading technology to tier four dynamic gas blending and adding incremental gas compression units.
We also stressed strong sales of turbines and turbine related services.
Power generation and industrial sales to users continue to remain positive due to favorable market conditions.
Transportation declined from a relatively low base, primarily due to timing and marine deliveries, which was partially offset by deliveries of international locomotives.
Dealer inventory increased by about $1 $4 billion in the first quarter, which was slightly above our expectations compared to a $1 $3 billion increase in the same quarter last year.
Construction industries the increase in dealer inventory was primarily due to stronger North American shipments, which remains our most constrained region.
As we mentioned last quarter over 70% of the combined dealer inventory in resource industries, and energy and transportation is supported by customer orders.
Moving to slide five we generated strong M. E&P free cash flow of $1 4 billion in the first quarter, we returned $1 billion to shareholders, which included about $600 million in dividends and $400 million and repurchase stock.
We remain proud of our dividend aristocrat status and continue to expect to return substantially all M. E&P free cash flow to shareholders over time through dividends and share repurchases.
Now on slide six I'll share some commentary on our expectations moving forward.
While we continue to closely monitor global macroeconomic conditions, our first quarter results lead us to expect that 2023 will be even better than we had previously anticipated on both the top and bottom line.
For 2023, we currently expect to be in the top half of the targeted range for both adjusted operating profit margin and in E&P free cash flow Andrew.
Andrew will provide additional color.
Before I discuss our outlook for key end markets I'll provide some color on how we expect our topline to progress through this year.
As I mentioned, we expect a strong top line for 2023 supported by price and higher sales to users with healthy underlying end markets. We expect higher sales in the second quarter compared to the first as is the typical seasonal pattern.
Looking to the second half of 2023. It is important to highlight the second half of last year included the dealer inventory build of $1 $4 billion as dealers began to restock their inventories we are not planning for this trend to repeat instead, we expect to see dealers decrease inventories compared to the first quarter levels and to end 2020.
Three about flat relative to the end of 2022.
Although we expect sales to users to remain positive for our primary segments in each quarter. Our planning assumption is that caterpillar second half sales will have a dealer inventory impact let me explain first although dealer inventory in some products and regions have normalized others remained constrained for example in North America.
Dealer inventory remains below the typical range for many products.
There is a greater excavator inventory in a few regions as supply dynamics improved in 2022, which coupled with the slowing in China has resulted in improved excavation product availability.
Given the improved availability of excavators, we expect that dealers will scale back their levels of excavator inventory in the second half of the year, even though demand remains healthy as.
As a reminder, dealers are independent businesses and control their own inventory.
Second in late 2023, we have scheduled a couple of new product changeovers and construction industry factories that will also impact the second half.
Now I'll discuss our outlook for key end markets this year, starting with construction industries.
In North America overall, we continue to see positive momentum in 2023, we expect growth in nonresidential construction in North America due to the positive impact of government related infrastructure investments and a healthy pipeline of construction projects.
Residential construction housing starts have softened the growth rate of our residential construction equipment remains positive as the supply chain pressures alleviate.
In Asia Pacific, Excluding China, we expect growth in construction industries due to public infrastructure spending in support of commodity prices.
As we mentioned during our previous earnings calls, we expect Chinese above 10 ton excavator industry to remain below 2022 levels due to low construction activity.
In 2023 sales in China are expected to be below the typical range of 5% to 10% of total caterpillar sales.
Any Amy business activity is now expected to increase versus last year based on based on healthy construction project activity, particularly strong construction demand in the middle East.
Although uncertain economic conditions remain European construction has proven to be more resilient than we previously anticipated.
Instruction activity in Latin America is expected to be down in 2023 versus the strong 2022 performance.
There was some concern about the potential impact of a commercial real estate slowdown, we estimate that north American commercial real estate accounts for about 1% of total construction industry sales any slowdown related to this sector should not have a significant impact on construction industries.
In resource industries, we expect healthy mining demand to continue as commodity prices remain above investment thresholds is.
As I've mentioned during the last few years customers remain capital disciplined which supports a gradual increase in mining over time.
We anticipate production utilization levels will remain elevated we also expect the ageing of the fleet and a lower level of park trucks to support future demand for our equipment and services. We continue to believe the energy transition will support increased commodity demand expanding our total addressable market and providing further opportunities for profitable growth.
In heavy construction and quarry and aggregates, we anticipate continued growth due to major infrastructure and nonresidential construction projects.
In energy and transportation, we expect to follow our normal seasonal pattern with higher sales in the second half of the year versus the first half.
And oil and gas reciprocating engines, although customers remain disciplined we are encouraged by continued strength in demand for both well servicing and gas compression.
Power generation reciprocating engine demand is expected to remain healthy, including strong data center growth.
New equipment orders in services for solar turbines, and both oil and gas and power generation are robust.
Industrial remains healthy.
In transportation, we anticipate strength in high speed marine as customers continue to upgrade aging fleets.
Moving to slide seven we are contributing to our reduced carbon future and continue to invest in new products technologies and services to help our customers achieve their climate related the objectives.
We recently completed an upgraded more than 50 models across our entire next generation hydraulic excavator line, the new models reduce fuel consumption by up to 25% compared to previous models and provide another option for customers to lower emissions, while improving operational efficiency.
A customer can realize meaningful emissions reductions by simply moving to the newest Nextgen model.
This example, it reinforces our ongoing sustainability leadership and how we help our customers build a better more sustainable world.
In addition, we look forward to issuing our 18th annual sustainability report in May.
With that I will turn the call over to Andrew.
Thanks, Jim and good morning, everyone I'll begin by providing further color on our first quarter results, including the performance of our segments.
Then I'll cover the balance sheet and <unk> free cash flow before concluding with a few comments on the full year and our assumptions for the second quarter.
Beginning on slide eight sales and revenues for the first quarter increased by 17% or $3 $3 billion to $15 9 billion.
The sales increase versus the prior year was due to strong price realizations and higher volume, partially offset by currency impacts.
Sales were higher than we had expected in January with price realization dealer inventory and end user demand each slightly better than we had anticipated.
Operating profit increased by 47% or $876 million to $2 7 billion.
Which includes the impacts of the divestiture of the company's long haul business.
Adjusted operating profit increased by 79%, a $1 5 billion to $3 3 billion.
Favorable price realization and higher sales volume was partially offset by higher manufacturing costs.
The adjusted operating profit margin was 21, 1% an increase of 740 basis points versus the prior year.
As Jim mentioned, the adjusted operating margin was much better than we anticipated.
Lower than expected manufacturing costs, including efficiencies and absorption with the largest variable while price realization and volume were also stronger than we had envisaged.
I'll provide additional color in a moment.
Adjusted profit per share increased by 70% to $4 91 in the first quarter.
Compared to $2 88 in the first quarter of last year.
Adjusted profit per share in the first quarter of 2023, excluding pre tax restructuring costs of $611 million.
Most of this related to the noncash charge from the divestiture of the company's long haul business.
Yeah.
Other income of $32 million in the quarter was lower than the first quarter of 2022 by $221 million.
The year over year decline included about $100 million unfavorable currency impact related to <unk> balance sheet translation.
And in adverse impact of $80 million for pension expense.
The dollar strength March maybe since our last earnings call. So the currency impact within the first quarter of 2023 was about $30 million better than we had anticipated when we spoke to you in January .
Finally, the provision for income taxes in the first quarter, excluding discrete items.
Flex it a global and new effective tax rate of 23%.
Moving on to slide nine to mine.
The 17% increase in the top line versus the prior year was driven by favorable price realization and higher sales volume while currency remained a headwind to sales.
Volume improved in part due to a 13% increase in sales to users.
The impact from changes in dealer inventory was minimal as the $1 $4 billion build in the first quarter was similar to that seen in the first quarter 2022.
Services sales volume was slightly down mainly due to dealer ordering patents while services to their customers remain positive.
Compared to our expectations a quarter ago sales were higher than we anticipated largely due to slightly stronger volume and better than expected price realization.
On volume sales to users outpaced our expectations due to strong demand.
In addition, the improving supply chain supported high levels of production across our primary segments.
This has enabled dealers to increase their inventory levels ahead of the selling season by slightly more than we had expected.
Moving to slide 10 first quarter operating profit increased by 47% to $2 7 billion.
Adjusted operating profit increased by 79% versus the prior year quarter as favorable price realizations outpaced higher manufacturing costs.
Sales volume was also a benefit.
Our first quarter adjusted operating profit margin of 21, 1% versus 740 basis point increase versus the prior year.
Now let me explain why adjusted operating profit margin was so much better than we had expected.
While manufacturing cost did increase year over year. The increase was less than we had anticipated and was the most important factor in the quarter.
As we've mentioned volumes were better than expected due to favorable demand and improvements in the supply chain.
This helped manufacturing cost was both factory efficiency and cost absorption were better than expected.
Freight costs were also lower than we had anticipated due to lower premium freight utilization and rate reductions.
Material costs were in line with our expectations and did not impact the margin outperformance.
In addition to lower manufacturing costs cost realization was also stronger than we had anticipated a quarter ago.
Stronger than anticipated volume had a smaller beneficial impacts on margins.
Spend on strategic investments was also lower than I expected as project spend ramped up slower than we had planned.
Moving to slide 11, I'll review segment performance.
Starting with construction industry sales increased by 10% in the first quarter to $6 7 billion.
Favorable price realization, partially offset by lower sales volume and unfavorable currency impacts.
The decrease in sales volume was driven by the impact from changes in dealer inventories, which increased by less than the first quarter of 2023, when compared to the prior year.
Compared to our expectations sales were higher due to stronger volumes.
While sales to end users, whereas we've anticipated the dealer inventory increase was slightly above our expectations.
By region sales in North America rose by 33% due to favorable price realization and higher sales volume.
Supply chain improvements enabled stronger than expected shipments in North America supported supporting dealer restocking in the region.
This is a positive as North America continues to be our most constrained region from a dealer inventory perspective.
Sales in Latin America decreased by 4%, primarily due to lower sales volume, partially offset by favorable price realization.
<unk> sales increased by 5% on favorable price realization Cos.
Offset by favorable currency impacts.
Sales in Asia Pacific decreased by 21%, primarily due to lower sales volume and unfavorable currency impacts partially offset by favorable price realization.
First quarter profit for construction industries increased by 69% versus the prior year to $1 8 billion.
Price realization mainly drove the increase.
This was partially offset by lower sales volume, including an unfavorable product mix and higher manufacturing costs.
The segment's operating margin of 26, 5% was an increase of 920 basis points versus last year.
The segment margin for the quarter exceeded our expectations on moderating manufacturing costs and better than expected price and volume.
Manufacturing costs were lower than we had expected on favorable freight manufacturing efficiencies and absorption.
Production volume was more favorable than we had anticipated which drove the usual favorable benefits margins from the.
Fourth quarter to the first.
You will recall that in January we said that we did not expect that to happen.
Turning to slide 12 resource industries sales grew by 21% in the first quarter to $3 4 billion.
The increase was primarily due to favorable price realization and higher sales volume.
Although after market sales volumes were lower in resource industries due to dealer buying patterns dealer services to customers remain positive.
First quarter profit for resource industries increased by 112% versus the prior year to $764 million, mainly due to favorable price realization and higher sales volume.
This was partially offset by unfavorable manufacturing costs.
The segment's operating margin of 22, 3% was an increase of 950 basis points versus last year.
Segment margin was better than we expected due to lower manufacturing costs, including favorable absorption efficiencies in freight.
Price realization and volume benefits also exceeded our expectations.
Now on slide 13.
Energy and transportation sales increased by 24% from the first quarter to $6 3 billion.
Sales up double digits across all applications.
Oil and gas sales increased by 39% power generation sales by 27% industrial sales rose by 23% and finally transportation sales increased by 14%.
First quarter profit for energy and transportation increased by 96% versus the prior year to $1 1 billion.
The increase was mainly due to favorable price realization and higher sales volume.
Unfavorable manufacturing costs, and higher SG&A and R&D expenses access as a partial offset.
SG&A and R&D expenses increased primarily due to investments aligned with our strategic initiatives, including electrification and services growth.
The segment's operating margin of 16, 9% was an increase of 620 basis points versus last year, but lower than the fourth quarter as is typical from a seasonality perspective.
Compared to our expectations last quarter margin was better than anticipated on lower manufacturing costs due in part to favorable absorption.
Volume was also modestly stronger than we had expected.
Moving to slide 14 financial products revenue increased by 15% to $902 million.
Primarily due to higher average financing rates across all regions.
Segment profit decreased by 3% to $232 million.
The slight profit decrease was mainly due to unfavorable impacts from equity securities currency exchange losses and <unk>.
Mark to market adjustments on derivative contracts.
However, higher net yield on average, earning assets and lower provision for credit losses acted as a partial offset.
Business activity remains strong and our portfolio continues to perform well.
Postures in the quarter with two points of Rosa represent a five basis point improvement compared to the first quarter of 2022.
This is the lowest first quarter past use percentage since 2006.
And whilst retail new business volume declined compared to the first quarter of 2022. This was expected as higher interest rates drove more cash deals and increased competition from banks.
Finally, we continue to see strong demand for used equipment as prices remain elevated while used equipment inventory is at historic lows.
Before I move on I want to point out the cat financial has strong liquidity and broad access to funding.
We are funded through the wholesale debt markets rather than from customer deposits and we match assets and liabilities based on duration currency and interest rate profile.
As we've mentioned previously in a rising interest rate environment banks are able to provide more competitive interest rates in cat financial and we tend to lose some share of the machines financed.
Now on slide 15, we continue to generate strong free cash flows.
<unk> free cash flow of $1 $4 billion in the quarter was about a $1 8 billion increase compared to an outflow in the prior year.
The increase was primarily driven by higher profit.
This increase is notable in the quarter that included our annual short term incentive payout and a rising working capital impacted by an increase in caterpillar inventory.
As Jim mentioned following the strong half first strong first quarter, we expect to end the year in the top half of our <unk> free cash flow range of $4 billion to $8 billion.
Capex was around $400 million in the quarter and we still expect to spend around $1 5 billion for the year.
As Jim mentioned capital deployment was about $1 billion in the quarter for dividends and share repurchases.
Our balance sheet remains strong and we have ample liquidity with an enterprise cash balance of $6 8 billion.
Now on slide 16, I will share some high level assumptions for the full year, followed by the second quarter.
Looking at the full year, we expect a strong topline supported by price and higher sales to users with healthy underlying end markets.
As Jim mentioned, we expect full year reported sales for construction industries to be impacted by dealer inventory movements, particularly in the second half of the year.
Underlying demand remained strong and as we do expect construction industries' sales to users to show positive growth in the next three quarters.
We anticipate continued strength in resource industries and markets and stronger end user sales in 2023.
In addition, as typical seasonality would suggest we expect to see some sales ramp in the second half and energy and transportation given strong demand for large engines and chosen turbines.
Yeah.
Moving onto margins based on our current planning assumptions, we anticipate full year adjusted operating profit.
Profit margins to be in the top half of our target range.
Given the favorable impact of cost absorption in the first quarter, which we do not expect to recur.
We anticipate margins in the remaining quarters of the year will be lower in the first quarter level, while underlying demand in end markets remained strong.
Also despite the slower than expected start we anticipate the spend related to strategic investments within SG&A and R&D will ramp through the year.
We expect price to continue to be favorable although the absolute dollar value of the year over year price increases will moderate as we lap through the increases put through in 2022.
We also expect the relationship between price and manufacturing costs.
So the machines to normalize as the year progresses as we've now caught up to the manufacturing cost increases, which has outpaced price in late 2021 and early 2022.
This means that the benefits of margins of price outpacing manufacturing cost inflation will moderate tempering the possibility of further margin expansion.
Keep in mind similar to the first quarter, we still anticipate a headwind of about $80 million per quarter at the corporate level related to pension expense.
We also continue to anticipate restructuring expenses of around $700 million this year with around $100 million remaining following the first quarter.
And the global effective tax rate should be around 23% excluding discrete items.
Now on to our assumptions for the second quarter.
We expect higher sales in the second quarter compared to the prior year on strong sales to users and price.
Following the typical seasonal pattern, we expect higher sales in the second quarter as compared to the first.
We expect energy <unk> transportation sales will accelerate given strong sales to users which are supported by healthy demand.
We expect to report flattish sales levels compared to the first quarter and construction industries and resource industries.
Both segments are expected to report positive sales to users.
In the second quarter of 2022, we saw a decrease in dealer inventory of $400 million.
We expect a small decrease in the second quarter of 2023.
Specific to second quarter margins versus the prior year adjusted operating margins at the enterprise segment level should be substantially stronger than the prior on favorable price and volume.
However, we do expect to see a return to the typical seasonal pattern of lowest second quarter margins compared to the first quarter despite higher sales.
We expect the year over year benefit of price realization in the second quarter to moderate compared to the benefit we saw in the first quarter as we lapped prior year increases.
In addition, SG&A and R&D investment spend should increase as we continue to accelerate our strategic investments in areas like autonomy alternative fuels connectivity digital and electrification.
Finally, we do not anticipate the favorable absorption impact that we saw in the first quarter will be repeated.
At the segment level in construction industries, we expect lower second quarter margins compared to the first quarter largely due to the lack of a favorable impact from absorption and a ramp up in strategic investment spend.
Likewise second quarter margins in resource industries will likely be lower than the first quarter as is the typical seasonal pattern.
Conversely, energy and transportation should see a slight margin improvement compared to the first quarter levels supported by stronger sales volume as demand remains healthy.
Okay.
Now turning to slide 17, let me summarize.
Sales grew by 17% led by strong price realization and volume gains.
The adjusted operating profit margin increased by 740 basis points to 21, 1%.
<unk> free cash flow was strong at $1 4 billion and.
And we expect to be at the top half of our EMEA achieve free cash flow range of $4 billion to $8 billion for the full year.
After a strong first quarter recounting expect our 2023 adjusted operate.
Profit margins will be in the top half of our target range.
The environment remains positive with improving supply chain dynamics are strong backlog and healthy underlying end markets.
We will 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 to one question per analyst.
Clarification of satire please.
Please rejoin the queue.
Your first question comes from the line of Rob Wertheimer with Melius Research. Your line is now open.
Thank you good morning, Rob My first one my question. Good morning. My question is really on North American construction.
I'm curious whether your end users have seen infrastructure dollars starting to flow has started to make orders based on that whether you are dealers make orders in anticipation of that or whether a lot of that is still ahead.
I'll stop there.
Yes, Rob we have seen some positive impact of those infrastructure dollars start to flow.
The projects that don't require a lot of permitting things like a.
Resurfacing roads that kind of activity has already started and we're seeing a positive benefit of that and one of the things of course when customers believe there is a pipeline of projects coming there or more likely typically to make that capital investment to make a purchase of a piece of new equipment, but yes. It has started and we expect it to continue for some time.
Thank you.
Your next question comes from the line of Tami Zakaria with Jpmorgan. Your line is now open.
Hi, good morning, Thanks, so much for taking my question.
Hi Fi.
Operating margin expectation for the year I think you said you're expecting it to be at the top.
Yes.
Can you remind us what that exactly.
Exactly is are we talking about the 18 to 21.
Brooklyn that Lisa.
The prior quarter and present broken out what exactly is that.
Yes, so the timing to be clear and I realize as we were saying it could be interpreted in two ways, one which is it could it be the 10% to 21% range no that is not what we were referring to.
If you remember we have a range of three.
3% range based on different levels of sales.
Sales revenues on revenues that is where we're talking about so for example, if.
Youre, assuming a certain.
Will of revenues if you remember the graph we produce we've given you that will show a margin range, we expect to be in the top half of that 3% range at that level of sales revenues for.
For the for the year.
Okay got it that's helpful. Thank you Tony.
Thank you Tim.
Your next question comes from the line of Michael Feniger with Bank of America. Your line is now open.
Thank you the market is worried about dealer destocking and the impact your construction margin in prior cycle margins came under heavy pressure when there was a big Destocking event is there anything different in terms of how cat is managing its production youre strong pricing dynamic in.
<unk> management with you and your dealers that we should be thinking about this cycle compared to prior cycles.
Yes, so certainly one of things we've done is worked hard on <unk> process over the last few years.
To to really minimize the impact of that kind of an issue.
Firstly to keep in mind the way we are the market is positioned we have strong sales to users and we feel good about the underlying demand in our end markets. So I'll start with that.
During a period of supply constraints, which which it really has occurred because of all the issues Youre aware of during last few years, it's not unusual for us to have dealers order in a bit more bit more and they couldnt really.
Get the kind of dealer inventory that they would like to have.
<unk> been able with some easing in supply chain, although we still have periods areas of real constraint. They had been able to start to increase dealer inventory, having said that we have talked about the fact that we expect dealer inventory to end the year about flat as to where it ended in 2022 and expect a slight decrease during.
The year, but again with our <unk> process. The way we look at that now the way we work with our dealers were comfortable in that process that we've really improved it.
So let me just add because obviously one of the concerns.
We talk about dealer inventory in terms of a global dealer inventory number where we talk about the three to four months. There are some areas with some products, which are actually below the bottom end of that range.
And so we do not see at this stage anyway or apart from potentially with excavation where there is actually any level of stocking, which even gets close to the top end of that range.
So it is.
Really you have to look at it product by product and again just to remind you that.
Last year's build in dealer inventory, 60% of that related to <unk> and to energy and transportation of which 70% of that more than 70% of that is covered by firm customer orders.
This is I think with respect a little bit misunderstood by the market. We are not in a situation, where we are allowing or expecting dealer inventory to become a headwind for us at anytime in the next few quarters and dealer inventories within the typical range of three to four months and again we have.
Strong.
Market conditions.
Okay.
Your next question comes from the line of Jamie Cook with Credit Suisse. Your line is now open hi, good morning, and congratulations on a nice quarter I guess.
Thanks, Jamie.
Jim.
I think he is going to be worried that the performance. This quarter is backward looking so can you speak to how youre thinking about backlog or book to bill in the back half of the year can that continue to be positive do you think backlog will be higher at the end of this year versus where we were this quarter and then just my second question Andrew on the margin can you talk to you Mark.
<unk> in the back half of the second half versus first half.
Just trying to understand how much lower the margins will be in the second half and what's being weighed down by strategic investment. Thank you.
Yes, certainly Jamie first to answer your first question of backlog. We are encouraged by the very strong backlog that we have it's flat compared to last quarter, but it's at a very healthy level again, we have healthy level up.
Demand as well as I mentioned earlier are some supply chain constraints have started to ease and when in fact availability improves dealers often wait a bit longer to place orders for new equipment and that is that is part of what happens, but again oil and gas is strong we have.
Mentioned earlier that our solar turbines business, a strong cat oil and gas is strong.
But again, we feel good about the market conditions and the backlog reflects that.
Yeah, and again just to add to that before talking about margins just to remind you backlog is one of the metrics. We look at to look at where we think about demand the demand signal.
Really does often reflect availability.
And therefore, often is one part of that equation. Other things, we look at sues order rates and also had conversations with dealers, which gives us optimism rather than just purely focusing on the backlog per se.
With regards to margins.
As we said.
In the second half you would normally see with protium, returning more to a notes more typical pattern.
Within construction, we Didnt expect that if you remember last in January we didn't expect to see the normal increase from the fourth quarter to the first we did we would now expect to see the normal pattern of margins being declining as we go through the year, that's a function of production.
Obviously as the year progresses, we produced less which impacts on absorption.
In particular, and also factory efficiencies within <unk> that tends to bounce around a little bit more and obviously is impacted by the level of sales and revenues.
<unk>, we expect margins actually will progress as we go through the year as per the normal pattern.
Thank you.
Okay.
Your next question comes from the line of David Raso with Evercore. Your line is now open hi. Thank you first just a clarification when you speak of the second half of dealer inventory Destocking.
Just making sure I understand the commentary that.
The destock versus there is some normal seasonality to it.
Excavators really might be a destock I know, it's really hard to get those there's right now to Brazil. So I am just trying to understand is it a destock or is it sort of normal seasonality first but then different question.
That's a clarification.
So just to clarify David obviously versus last year, where we saw an increase so module $700 million increase in both third and the fourth quarter. We would expect to decrease this year, yes, its not unseasonable, but it is a decrease versus the year over year. So just that does create a gap, which we overall.
So thats part of the reason, we just highlighting and now just to remind everybody, yes, theres a normal spring selling season.
Yes, sorry, David you're exactly right yeah. Okay. I just wanted to go ahead with something unique.
Behavioral pattern is to take it down in the second half but.
Correct correct real simple question 24.
I know lead times in some areas are getting better some are still challenged.
But it does appear the dealers are willing to order a little earlier for next year than a normal at this time of the year ordering for next year. Just any early signs you have on order books for 24, I think it would be very helpful. Thank you.
Yes.
It is still too early to sort of that certainly predict 2024 as I mentioned because availability is improving that gives dealers the opportunity for some products to wait a bit longer when they place their orders and thats not the case for every product, but it is too early to really make a call on 2024.
Okay.
Your next question comes from the line of Jerry Revich with Goldman Sachs. Your line is now open.
Gerry Gerry.
Yes.
Jim Andrew Ryan.
Thanks for making time I'm wondering if you could just talk about the margins for you folks are now at the high end of your framework range and supply chain performance looks like it's improving from here and for the rest of the industry.
Margins are at the very high end of the ranges as well how do you think about the risk of pricing concessions for the industry from here.
As supply improves further obviously, we havent seen discounting from you folks in.
In the past, but I'm wondering if you could talk about it if the cycles different at all given just the more complexity.
And of course as you know we serve a variety of industries and there is it.
It's not.
One size fits all so we look very carefully at the market conditions and the competitive situation for each product that we sell into the various markets that we have.
Certainly in some areas product is still constrained and is still quite challenging to get product and in others as we mentioned like in excavation.
There is more availability so that has an impact as well, but really what we do is as you can imagine look at we always take into account our cost inputs and then we'd look at the competitive situation for each product and each market and we make a decision based on that.
Yeah.
Yes.
Your next question comes from the line of Steve Volkmann with Jefferies. Your line is now open.
Great Good morning, everybody.
I wanted to go back Jim I think I heard you say that you thought North American commercial construction was like 1% of Ci is correct me, if I got that wrong, but.
It made me Wonder what you think really the key drivers are of that business. So that we can sort of monitor those going forward.
What are the key drivers of commercial construction.
If commercial is only 1% of Ci, what's the other 99%.
So when we talk a lot about nonresidential and we've talked about the fact that we are quite encouraged by legislation that has passed whether it's AI Haa the chips Act the IRR.
So again.
It wasn't one of the things we wanted to do was because there had been a lot of commentary frankly about commercial real estate. We wanted to just clarify that it's a very small portion of Ci.
Because it seems to be getting a lot more play than it deserved quite frankly.
Yes, great. Thank you.
Yes, sorry, just wanted to clarify one point that I responded to the question that yes, it will be dealer inventory.
Destocking occurring in the second half of the year, but it will not impact us we will still see positive sales momentum in those quarters. So it does not have an impact would takes us down year over year at any point in time in the next few quarters just to clarify that.
Your next question comes from the line of Chad Keller with Bernstein.
Your line is now open.
Hi, good morning, everyone.
Couple of questions. So first can you comment on that.
In construction today versus six months ago.
And then can you just clarify your comments about the second half.
Talk about Destocking from factory maintenance.
Does that mean that <unk> will be seasonally weaker.
The normal on a sequential basis.
Yeah, So lead times.
So because of easing supply chain constraints in some areas lead times have improved we still really have challenges in certain areas.
Earthmoving is a great example, we have we had challenges around.
<unk>.
Okay.
Sorry, sorry carry on.
Oh, yes, yes, yes.
To clarify.
You talked about Destocking.
In the second half. So I just wanted to know does that mean that <unk> will be seasonally weaker than the normal honestly, yes.
Yes back to the comment up as I said to David earlier, we did have inventory builds in the third and fourth quarters of last year. So youll running against a comparative which has a build versus a decrease so year over year that does impact what.
What would be the normal seasonal pattern, obviously, while other factors come into that price and also what underlying volume demand is but that will have an impact on our reported sales in those quarters. So we're just highlighting that so that as you think about your models you don't build the normals.
<unk> patent.
So those models as you look out for the next several quarters.
Great. Thank you.
Your next question comes from the line of John Joyner with BMO capital markets. Your line is now open.
Why would there be dealer destocking and not some restocking I mean does it possibly imply a bit of hesitation among dealers when looking ahead.
I don't believe Thats, the case and again as I mentioned as availability improves and lead times decrease due to easy and supply chain challenges, it's not unusual as we've looked at.
Look in the past, it's not unusual for dealers to they can wait longer to place orders and they need a bit less in inventory because we can respond more quickly. So it's not surprising to have that happen and also if you recall, we've talked about the new sales and operations planning process and one of the things we are trying to avoid through.
Through that process is dealers holding more inventory.
That is really necessary they are independent businesses that make their own decisions about inventory, but we tried to work with them to avoid any overstocking, which then has an impact when we come later.
Later on where you have to destock. So we're trying just to be more proactive in that regard and we had been historically.
And again, when we can respond more quickly to dealer orders.
You should feel comfortable holding a bit less inventory.
Got it thank you.
Your next question comes from the line of Matt Alcott with TD Cowen. Your line is now open.
Good morning.
Good morning.
Good morning, I know the backlog was unchanged, but how does the timing of the backlog change I mean does it go out further any orders get pushed out because of all the macro uncertainty.
And did you have you guys have any major cancellations that were offset by new orders.
No what we have not seen any major cancellations and we feel quite good about the quality of the backlog that we have of course much of it is for for solar turbines for oil and gas for mining.
So again, we feel quite good about the quality of that backlog and we haven't seen major cancellations.
Your next question comes from the line of Kristen Owen with Oppenheimer. Your line is now open.
Great. Thank you for taking the question.
Richard up here, a little bit and ask you to talk about the LNG announcement that you recently made for zero emission fleet.
It looks like that includes some related infrastructure. So just a couple of point of <unk> questions. There first how do you see the rollout progression of a product a project like this.
And then second how should we think about this in terms of a blueprint for future mine site de carbonization opportunities.
For that how do you think about packaging that sort of deal. Thank you.
Yes, so certainly we've had a number of requests from.
Many of our mining customers in MG is one of them to help them decarbonize their operations and so we are working within EMG, specifically to help to provide battery powered machines to allow them to execute that project. So again.
It's a collaborative process, we're working closely with them.
We're working through commercial issues with them.
But.
We feel quite good about where we are we demonstrated in November to a number of our customers are fully loaded battery powered mining large mining truck operating diesel powered performance in terms of speed fully loaded.
On the flat going up the hill. So again, we feel good about where we are but it's a process. It's a multi year process that we're working with our customers.
Okay.
Your next question comes from the line of Tim Thein with Citi. Your line is now open.
Thank you good morning.
Had a question just on.
Hey, good morning.
Yes.
The improvement or whatever improvement you are seeing.
And our supply chains, and a little bit better visibility and thus.
Your ability to react faster.
Does that Andrew how do we think about that.
The interplay with that as we go through the year and cat one inventory.
And I know theres, some theres been flatter and somewhat Palo <unk> inflation and other factors, but.
Just thinking of that impact as we go through the year and ultimately the impact from an absorption standpoint.
If in fact, we start working that down thank you.
Yes, so obviously some of our assumptions all but we do not expect the absorption impact to continue and obviously, yes. Some of that will reverse as we.
Move product out of the plant into into the dealer channel.
And Thats forecast said within our within our expectations for margins as we go through the remainder of the year the.
The other factor obviously to take into account is the potential benefit to cash flow.
Sort of monitoring with zero inventory, biopharma, but I'm sort of curious here.