Shares of Caterpillar (CAT Free Caterpillar Stock Report) are down just a bit today even after the heavy equipment manufacturer missed third-quarter expectations. Sales of $9.5 billion declined nearly 26% from the year-earlier period and were below our $10.7 billion estimate. For this blue-chip company, this marked the latest in a string of disappointing performances, reflecting the lingering effects of a worldwide commodities slump. Indeed, poor fundamentals for almost all metals are proving to be detrimental to the company's bread-and-butter end market, which is the mining sector. Geographically, results in countries with slowing economic activity, including Brazil and China, were especially weak. Other sore spots were the construction, oil and gas, and rail end markets.

The company had gone to great lengths to prepare Wall Street for a weaker-than-expected start to 2016, which might be contributing to the limited response. In March, Caterpillar warned that weak demand and a strong dollar remained stumbling blocks. More recently, and ahead of the earnings release, management disclosed weak retail sales comparisons for the latest quarter. Monthly figures for the March period showed year-over-year declines between 13% and 21%. It also painted an unfavorable picture for Caterpillar's Energy & Transportation division. Despite an improvement in commodities markets, which is likely due to a modest pullback in the value of the U.S. dollar recently, industrywide investment on new long-term energy projects remains at depressed levels. In fact, retail sales there fell more than 40% in the first quarter, punctuated by more than a 50% drop in March. Conditions within the Resource Industries unit also were poor, as tepid demand for new machines in the Asia Pacific region, notably China, resulted in a 25% plunge in sales.

Meantime, Caterpillar sharply cut expenses, with variable manufacturing costs falling by $500 million since the first half of 2015, but that was insufficient to overcome a severely subdued appetite for new machines. Altogether, share earnings of $0.67 fell below the prior-year tally of $1.86 and our $0.98 estimate.

Even though management is seeing signs of stabilization, with better order activity at BAUMA (the world’s leading trade fair for the many industries the company serves), it is taking a cautious stance for the remainder of 2016. Crude prices have improved of late, but companies have yet to loosen their respective purse strings. With a good number of exploration and production (E&P) companies forced to curtail spending and preserve capital, orders are likely to trend lower in that end market. In fact, management is looking for a steep sales decline at the Energy & Transportation division in the current year. Moreover, the glut of supply in the mining arena is liable to result in lingering softness there, with Caterpillar anticipating a 15%-20% sales pullback in the Resource Industries unit.

Caterpillar has lowered the midpoint of this year's sales forecast by 2%, leaving the current range at $40 billion-$42 billion. The profit outlook is now $3.70 per share, excluding estimated restructuring costs of $550 million. We have tempered our 2016 top- and bottom-line estimates, which are $40.5 billion and $3.60 a share, respectively.

From an investment standpoint, Caterpillar shares, notwithstanding today's slight early pullback, have come back nicely after hitting a 52-week low in early January. However, given that the company faces a myriad of challenges resulting from a depressed commodities markets and a subsequent decline in heavy equipment sales, the near term may still prove to be quite volatile for Caterpillar stock. For those with a longer-term investment horizon, this good-quality stock offers decent risk-adjusted capital gains potential, which is only enhanced by the company's well-covered dividend payout.

About The Company: Caterpillar Incorporated is the world’s largest producer of earthmoving equipment. Major global markets include road building, mining, logging, agriculture, petroleum, and general construction. Products include tractors, scrapers, graders, compactors, loaders, off-highway truck engines, and pipelayers. Also makes diesel & turbine engines and lift trucks. 

At the time of this article’s writing, the author did not have positions in any of the companies mentioned.