Don't Expect Earth-Shattering Results From Caterpillar

NEW YORK (TheStreet) -- With only 3% gains in 2013, industrial earth-moving giant Caterpillar (CAT) was somewhat punished for the tough conditions that existed in the mining and construction industry. Despite analysts' optimism that commercial construction would be "earth-shattering," things just didn't pickup as quickly as the Street hoped, even with the modest improvements seen in the housing recovery.

As I've mentioned in a recent article discussing Stanley Black & Decker (SWK), the housing-related stocks have not participated in the recovery as much as analysts had predicted. Nevertheless, with 2014 now well under way, investors have already begun making moves to position themselves for another expected recovery, this time in commercial construction.

The bet is on companies like Caterpillar that are perceived as bulletproof -- able to endure the downturns of cyclical construction. Last year's 3% gains told a different story, however. While I understand the appeal of buying a laggard stock ahead of a possible recovery, it's also important to understand that valuation does matter in this industry.

In the case of Caterpillar, there are also some operational deficits that management must resolve. Not the least of which is the company's persistent struggle with machinery revenue, which led to a 44% decline in profits in the October quarter.

It's true the likes of Mohawk Industries (MHK) and Joy Global (JOY) haven't fared any better. Even so, despite the weak 2013 stock performance, investors must reconcile that this stock may not be as cheap as the Street believes, given its underlying battle with fundamentals.

On Monday, the company will report its fourth quarter and full-year results. The Street will be looking for $1.75 in earnings per share on revenue of $14.5 billion, which would represent a year-over-year revenue decline of close to 12%. That's not where the focus should be placed, though.

Instead, I believe the focus of this quarter should be on how management is dealing with its resource business, particularly the mining segment, which nosedived last quarter by 42%. This, as you may recall, was highlighted by a 63% plunge in the Asia-Pacific region. Investors should also pay attention to Caterpillar's order rates, which still aren't picking up, even amid modest commodity production.

To that end, although a slight year-over-year or sequential uptick in revenue would be encouraging, I'm not holding my breath. By now it should be known that consolidated revenue results are expected to underperform for the foreseeable future. In fact, following the 18% revenue plummet in the October quarter, management projected flat revenue for all of 2014 while issuing the caveat "give or take 5%." So there you have it.

Placing a bet here on Caterpillar requires faith that management is able to make the necessary operational adjustments to combat, for instance, the slumping mining market. One of the ways this could be achieved would be cutting costs to improve margins. Because when compared to rivals Deere (DE) and Komatsu (KMTUY), Caterpillar's profitability has grossly underperformed. Yet Caterpillar's stock still carries a premium to both Deere and Komatsu.

This tells me that the Street still wants to love Caterpillar and is hoping that on Monday the company will produce "less bad" results. Even so, there isn't anything the company can do to change the fact that this industry may not return to earth-shattering results for a while. That said, if management can successfully align its costs with the industry's woes, Caterpillar should be able to stabilize its profits and balance sheet. That's a big "if," though.

Warren Buffett once said, "When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact." In other words, no matter how great a management team Caterpillar may have, the odds are not in the company's favor until the industry recovers. Accordingly, I would stay away from this stock until Caterpillar's revenue and profits are no longer crawling.

At the time of publication, the author held no position in any of the stocks mentioned.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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