Caterpillar Inc. (CAT) Earnings Call Transcript & Summary

Welcome, everyone, to the Caterpillar fireside chat at the Barclays Industrial Select Conference. I'm Alex Kapper, Vice President of Investor Relations for Caterpillar. We just want to make a few quick reminders before we get started. Today, we may make forward-looking statements, which are subject to risks and uncertainties. For a full list of the risks which may cause our actual results to vary materially. Please see our SEC filings, including our 10-K, which was filed just last week. We may refer to non-GAAP numbers as well. So any reconciliation to U.S. GAAP numbers, please see the appendix of our earnings presentation. And with that, I'll hand it over to our host, Adam Seiden.

Great. Thanks so much, Alex, and thank you to the Caterpillar team for being here. Both Alex, Rob, and of course, star of the show today, Andrew Bonfield. So the format of this session here is going to be a hybrid between a little bit of remarks from Andrew as well as some questions from myself. Like most of the presentations here and sessions here, we do invite your participation through the gadgets that are sitting on your table when we get to the audience response questions. So with that, Andrew, good to have you back in Miami here.

Yes. Thanks, Adam, and good morning, everybody. Let me just start quickly just to recap a little bit about our strategy. So just to remind you, definition of winning is to grow absolute OPACC dollars. The reason why we call -- OPACC is operating profit after capital charge, it's the center of our strategy. The purpose there actually is, we believe that's got the highest correlation to free cash flow, which actually then creates total shareholder return. And if you look at our performance over the last -- since 2020, Caterpillar has generated top quartile total shareholder return and at the same time, grown OPACC dollars by 4.1x. So that strategy is working, that's the benefit and the effect that our shareholders have seen through that. As you know, in November, many of you know, we set out our new Investor Day targets. There's a couple of new ones, which were there, which haven't been previously particularly around sales and revenues, which is to grow sales and revenues between 5% and 7% between now on average between now and 2030. Last year, we achieved 4%, slightly underneath that goal. If you remember at the beginning of the year, we actually expected sales to be about flattish or down slightly. So actually, it was a pretty good performance and reflects the benefit of some of the merchandising programs, particularly, we've been doing in our Construction business. Last year, our Construction Industry sales grew by -- underlying sales to users grew by around 5% in a down market. So a strong performance there. We continue to deliver on operating margin within our operating margin target ranges, which I'll talk about in a moment. Last year, it was towards bottom end impacted -- that impacted us in 2025, without tariffs, it would have been towards the top end of the range. Again, continue to focus on growing services. Services did grow modestly last year, just over $24 billion and on track to deliver our target of $30 billion by 2030. Free cash flow continues to be strong. We'll talk a little bit more about that in a moment. We delivered -- returned about 84% of free cash flow to shareholders through a mixture of dividends and buybacks and grew the dividend by 7% last year. These are some of our additional targets we've given outside below into our segments. The top three related to sales targets, which relate to obviously help underpin the 5% to 7% growth. The balance really relates to our technology and digital activities, which is where a significant amount of our investment dollars are going as we move forward through the strategy and into 2030. Operating margin target range has been changed. It used to be 10% to 22%, it's now 15% to 25%. We've upped the top end of the range from $72 billion now up to $100 billion. The pull-through at the top half of the range is exactly the same as the pull-through was at the bottom part of the range, around 31% on average. Obviously, one of the things that if you think about where we are going at the moment, we are expanding CapEx and capacity. So -- you won't get as quite as much operating leverage as you would have done historically at lower levels of sales and revenues. So that's part of the reason why we stuck to that range. We've always said you cannot grow margins to infinity and beyond. It is one of those things where, obviously, you balance out and that's why our real target, although the margin ranges are there for guidance is absolute OPACC dollars because that is, again, what we believe has the strongest correlation to total shareholder return. We continue to invest for profitable growth. CapEx this year will be around $3.5 billion, still less than 5% of revenues. We are doubling CapEx over the next 5 years versus the previous 5 years, but still very affordable within the strength of both of the balance sheet and the cash flow generation that we have. So although we are expanding capacity, this is not a significant investment in the context of Caterpillar as a whole. We continue to invest behind digital and technology, things like automation, connectivity, all of those things are important as part of our strategy and we'll improve our -- increase our investment by 2.5x between now and 2030. This is the chart, which actually is the one which I think is the real -- is the money shot it's the free cash flow chart, but it's one which actually shows the differentiation of Caterpillar versus many of our peers. Our free cash generation is really, really strong over the last three years. We generated in excess of $9 billion of free cash flow. It's the highest average free cash flow generation within the S&P 500 Industrials. We are a strong generator of cash. And that occurs even in times where even if you look in 2020 during COVID, we still maintain positive free cash flow that year. It is one of the strengths of the company. It is one of the things, the benefits of OPACC, which has helped obviously drive that correlation to shareholder return. At the same time, we've grown the dividend for 32 consecutive years. We're a proud dividend aristocrat. Since 2019, we've grown dividend on average by 7.5x, 7.5%. At the same time, we've also talked about the fact that we expect that to grow high single-digit increases between now and 2030. And share repurchases have been revenue strong. So we've bought back since 2019. Part of the strategy was to be in the market more consistently with share buybacks. We have done -- we've actually, until last year, we returned 99% of free cash flow, 84% last year. We'll do a slightly bigger ASR, accelerated share repurchase in the first quarter than we did last year. It's a bit of a way to cover that up. but effectively reduced the share count by 21% over that time period. We don't try market time. We're not looking to beat the market on average. We will look at it against a VWAP, the volume weighted average price, but actually just -- to give you context, the average price we bought those shares back is actually $226. So again, that's helped shareholder return as we go forward. So key takeaways, strong financial performance. We continue to invest for profitable growth, which supports our shareholder value creation as we move forward. So with that, Adam, over to you for questions.

Thanks, Andrew. I appreciate that overview of the company a bit on the strategy. So maybe to start off here. Lots of folks in the room here, lots of folks talking about data center, power gen and certainly, I think folks appreciate what you guys bring to the table there. but maybe for those folks that are a bit newer to the CAT story and are looking at that angle. Can you talk a little bit more about some of the other [ legs ] that are still here?

Yes. So it's -- the point being is, actually, we actually have broad-based business and a very diverse business, which is one of the things that people sometimes don't appreciate. And obviously, the three segments: Construction, Resource Industries and Power and Energy now. Within Power and Energy, it's not just a data center play. There's obviously particularly around oil and gas. If you think about the demand for the increased energy, that is going to require more gas. So we use recip engines, which is the same recip engines you can use for data center backup generation. It can be used in wellhead gas compression, and that can also be used in well servicing for actual oil exploration. Also, we have solar turbines, which you can use in, again, powered applications, but also principally actually using gas compression for pipelines. So if you think about the fact that, obviously, if we do need more electricity and electricity growth in demand is going to grow. Most of that in the short to medium term is going to come from gas. If it doesn't come from gas, coal may be another option. As you've seen, the administration here has talked about. Again, coal benefits mining business, our Resource Industries business. Resource Industries. If you think about what's happening in the world today, there's two parts of that business is mining, and then there's heavy construction, quarry and aggregates. Again, a lot of infrastructure spend still going on. A lot of the IIJA money is still being spent as we moved out. And if you think about, again, infrastructure spend around data centers. Again, that requires heavy construction. And then on the mining side, if you think about copper, gold, all of those commodities are very strong, iron ore and so forth are all required to build out infrastructure. And we are in a point of time where if you look at the average age of the fleet, it continues to age. Some of that reflects the fact that obviously, it sort of depends where the life of the mines are. But obviously, at some stage, there will be a replacement cycle. It's been happening, but it's very, very slow, much slower than people anticipated. That's not necessarily a bad thing because what that does mean is you actually see a more steady progression rather than the boom bust that we have seen in the mining cycle before. And then on the construction side, again, if you look around the world, North America construction remains strong. Nonresidential construction has been very strong. We've been doing particularly well, actually on the smaller side equipment, BCP, which tends to be used in residential construction. There's been some changes. And again, some of the merchandising programs we put back in place this year, have helped that particularly where we buy down interest rates for customers, which obviously isn't attractive. If you're a small landscape gardener and you want to buy a Skid Steer at a lower interest rate and a fixed payment is an attractive option. That's a good way of spending our merchandising dollars because we get a lot of that back through CAT Financial later on. But also, again, still infrastructure growth. But around the world, actually, that's been a bit mixed. So Middle East has been strong. Latin America has been growing. Asia PAC has been sort of mixed. China very weak, and we expect some improvement this year in 2026. And Europe has been pretty weak, although we expect some improvement as we look through 2026 as well. So again, it's a broad-based business. And then we haven't even talked to Power and Energy, things like transportation, which obviously is moving over to rail moving over to Resource Industries this year now as well. So there's quite a lot of activity. And again, that breadth of the portfolio helps and also obviously, the drive towards services helps reduce the amount of volatility you would see in a normal cycle.

Great. That's a great rundown. So you spoke a little earlier about some of the investments that CAT's been making. So how broad-based is that investment spend across CAT's portfolio these days? Or is it concentrated in one area?

Yes. It's -- I mean, obviously, from a CapEx perspective, a lot of the CapEx is obviously going today. A lot of the increases relating to the capacity increases we've announced for both electric powered -- large engines and also for solar. Effectively, within large engines, we're increasing our capacity by 1.25x. Large engines can be used in a number of different applications. They're not just for electric power. They can also be used for oil and gas applications and actually are used in large mining trucks as well. So they are multipurpose engines, which we're driving. And then in solar turbines with the -- now with the launch effectively of the TITAN 350 which is around a 38-megawatt turbine. We are seeing a lot of interest for that, and we are doubling capacity for solar turbines. That capacity will come in over a number of years. We started seeing a little bit last year, a little bit more towards the end of 2026, particularly on the large engine side, most of it in 2027 on the large engine side, and then solar probably '28 onwards.

Got it. And you're talking about the different parts of the portfolio a minute ago. So just does CI and RI get the same level of investment today versus when you first started as CFO at [ CAT ]?

Yes, they do. I mean it's -- for example, a lot of our digital investment is going on in CI. So not only do we have -- and also a lot of our technology investment is going into both CI and RI. For example, looking at the tech stack for our autonomous applications within RI as part of what we're doing to reconfigure that. We -- for those people who don't know, Caterpillar has moved over 7 billion tonnes of dirt autonomously over the years. We have over 700 mining trucks out there today operating autonomously. So again, that has been a strong part of the portfolio. But obviously, we're looking to make that even more efficient and then move that more into construction applications, which are different much more challenging in many ways. Lots, some of those are remote. We already have that, but obviously continue to invest to find ways of -- because one of the biggest pain points for many of our customers is labor and that skilled labor is a challenge. So looking at it again, we did a lot of the CES around technology, around some of the things we're working on. And then connectivity is really important. So connectivity, it's really about making sure we know what the machine is doing, where it is. We can actually help customers maintain or increase their uptime. That is really important for our customer base. Remember, in construction, if you think about it, a lot of the activity works in parallel -- [ in a series ], not in parallel. So you have to have your piece of equipment ready available at that point in time when you're ready to, for example, soil compaction. You may have moved dirt, but now you want to do soil compaction. If the machine doesn't work, at that point in time, you actually lose time on your job. So it's really important to be able to have machine uptime. Connectivity helps that by actually enabling us to help people with things like fault codes and then AI as well applications on top of that to actually help customers maintain or improve their uptime, maintain the serviceability of their equipment.

Great. So when we think through the backlog a bit, right, you guys talked through, I guess, AIP actually, it's one of the largest power gen orders ever for CAT. And that seems to come on top of what was already, what, about $10 billion plus in backlog growth this quarter. So could you talk a little bit about the size of AIP and then maybe for like compare and contrast, if not dollars, but like -- like how does it compare versus the Joule and Hunt announcements earlier?

Yes. I think it's about a gigawatt of power that's being applied there, obviously. And so it is slightly smaller than the Joule size. But again, it's just a reflection of the fact that these are significant opportunities for us. If you're a data center today and you're looking for a grid connection, you know often that is now under scrutiny. All the reports going on about how data centers are struggling, particularly given the pressure it's putting on customer bills. Having worked in a utility before. I know how much fun it is trying to go to the regulator to get a bill increase and to build out infrastructure is not easy. And so there's a cost to doing that for a data center. And there's also a time issue, either getting reconnection could take many years. and/or also you may be in a situation where you're waiting for a new power station and you're waiting for a GE Vernova turbine for '29, '30 before you can see one. So it means that the people are looking for other options. And one of the benefits of both our smaller turbines and research is availability compared to other options that are out there. So that's really been a driver and AIP is exactly that sort of where you're sitting there as a data center provider, and you're being -- going to be told, it's 3 years before you can start generating revenue or there's an option to use other options from a time value money perspective that may actually drive you to look at, say, CAT as a way of actually closing the gap.

Good. And with AIP and some of the other order momentum that you've seen in the business, I guess, is there a good way to think about how backlogs grow in '26 or maybe Q1 just given the size of that?

Yes. I mean, what I would say to you is that, obviously, normally within that business, you would see in CI and RI an increase in backlog normally in the fourth quarter, that would be normal because ahead of the summer selling season. Those are shorter lead times, so they tend to work through. So you will see some of that work through a little bit in the first quarter for CI. So that would not be -- that would be a normal seasonal pattern. Obviously, normally in power and energy, a lot of particularly things like solar tend to be orders which tend to get delivered towards the end of the year, given the packaging required around the turbine. So again, that tends to mean particularly in solar, you tend to have a buildup of backlog as you go through the year. Obviously, it's really around what orders can we take, what slots can we fill. If you saw historically, we've normally been able to provide around 70-plus percent of orders within one year. Currently, we're running at 62%. So again, slots are becoming more difficult to get and so there may be people putting out backlog orders later this quarter, AIP will be one which potentially will flow through into the first quarter.

And on those orders in the backlog that you spoke to, how are those set up in terms of like are there framework agreements, inflationary indices that they're set to? And what are those prices benchmarked to?

Yes. So I mean we have -- in a number of the longer-term contracts, you have an escalator in there, which may be an index or maybe related to future price increases. Again, it's a contract-by-contract basis. That is negotiated. Obviously, for -- and so most of the backlog has some form of price protection in it because, obviously, that's really important, particularly as you get to longer lead time items.

Great. You mentioned merchandising programs as well that paid off certainly for CAT quite significantly. So now sitting here in the first couple of months here in '26, what has been some of the feedback from dealers on that program from last year and how that's played out and what's the expectation set for this year?

Yes. I mean, again, as I mentioned, one of the great things last year was we actually saw end-user sales grow by 5% in the market in an industry that was generally flat to down last year. And part of that is the success of those merchandising programs. If I look in CAT Financial, for example, what we -- or what the proportion of the custom machines refinance actually went up quite significantly last year. And part of that, again, also reflects the fact that the merchandising programs were seen as a success. Obviously, for large customers, they have their own sources of finance. They don't necessarily always come to us. Some of them do because of the optionality. But obviously, for a small retail customer, it's a really a good option, particularly if you give a low single-digit interest rate for a 5-year. And that obviously helps their cash flows. And that's why, particularly within the small equipment, we actually saw a significant pickup of merchandising from that, which is good. And the aim is to continue to put those programs, keep those programs in place. If you think about what happened during the post COVID area, we probably took them down a little bit, which helped price because obviously, that fed through into a better price. Obviously, for the last 18 months, we've been taking that down price down in order to put that back. But it gives us a better balance and a better competitive situation. Remember always, from a CAT perspective, our brand promise is around the lowest total cost of ownership. That might not have a price premium may be higher upfront, but it's about quality productivity and actually the length of build to be rebuilt as part of our mantra as well, which means the machine life tends to be longer. And so that actually reduces your total cost of ownership. So again, having those things are important. And then obviously, our operating finance, particularly smaller customers would rather have a CAT Skid Steer than another brand.

I know a lot of folks in the audience tend to have questions on inventory. So maybe just thinking that the business -- if you think over the last couple of years, the business does feel a bit more comfortable running a bit higher than historical average dealer inventories. I don't know if you push back on that or not. Is that fair? And then I guess more of the bigger question that I'm after is, does that change the destock, restock dynamic that we've seen in prior cycles?

Yes. I mean I would push back a little bit because I think we still tend to -- dealers tend to think about the average of 3 to 4 months as the sort of level of inventory and we're still within that sort of normal range. There may be areas where we actually look within -- but again, that's a machine and we have a large portfolio of machines and not every machine is the same. And one of the areas where we might want to actually build inventory over time is say is having some more small equipment on the yard rather than just always having large excavators and big bulldozers because then that's a higher, faster moving piece of equipment. So there's things we tend to look at. Again, we talk to the market about it as if it's one number. And it's 150 dealers around the world, probably they have 90 pieces of different type of equipment that they may be stocking on the yard, it's complex. So -- And so -- but I think that what we are trying to do is work closely with our dealers to make sure we never get into an excess inventory position. I think that would be the way I would frame it because obviously excess inventory does create an issue where we then end up having -- it causes us production issues because you haven't just slowed down the factories and then it also causes them to have issues on their end as well on clearing their inventory out. So it's better for us to actually help work with them and try to manage their independent businesses than make their own decisions but try to work with them to make sure we don't end up in a situation where we have been in the past. I mean, that was back in the 2012 era. Yes, we're not -- we're trying to avoid those sorts of issues.

I appreciate you took the inventory number from being one number to two numbers. So at least we got a little bit of a bounce there. On the -- thinking through other topical stuff like tariffs, right? So what country-specific relationships should we be paying attention to? It feels like every day or week or so, we see another country in the headlines about a potential deal or not, India being one of them most recently. And then thinking about the other side of that, what -- how large is that basket of mitigation measures available to CAT on some of this stuff?

Yes. So I mean, obviously, what we always remember is CAT is a net exporter out of the U.S. So we are -- the administration is trying to encourage to manufacture more in the U.S. than it produces elsewhere. But obviously, we are a relatively low volume producer. So there are places where we have centers of excellence for individual products. The tariff actually -- I think there's two parts to the tariffs, obviously, the 232, which relate to steel and aluminum, which are very different from, say, the IEEPA tariffs, which are a little bit more broad-based, country-specific. And there's some of the challenge around some of the IEEPA's tariffs. We have seen those fluctuate, and we'll continue to see those fluctuate. I'm not going to go country specific about which ones are bigger. But obviously, we keep a very close eye on things, obviously, India, as you say, has reduced the tariff and obviously, we'll update what we think that impact of that will be when we report our first quarter results in -- at the end of April. But if it was material enough, we would obviously come out as we did last August with a statement about what we would update the impact if it became material. But that stage is not -- India is not that material in the context of the total. On the mitigation side, it's around looking at sourcing changes. It's looking about making sure you maximize the use of where there are exemptions or there are duty drawbacks and things like that, that you can use. Obviously, we've been trying to avoid doing too many sourcing changes straightaway because obviously, that is one thing which obviously we don't want to do something and then find out 6 months later, the tariff has gone down and then you regret the action. So we've been very mindful about doing that. But overall, we'll -- as we say over time, our intent is to mitigate the impact of tariffs and to be around the midpoint margin target range. So that's really -- obviously, this year, we still got a little bit of a way to go.

Got it. And just a really quick one first before we get to the audience response, it's going to be just on the capacity ramp, I think you gave a little bit of a progression earlier to tell us how you think things should be through. So just what's assumed in your guidance for 2026 for the capacity ramp in power gen?

Yes. We actually have built -- we've got some growth in -- obviously, in Power and Energy, we haven't specifically gone by capacity from that perspective, but we should see some capacity come online. Obviously, working really hard to see if we can bring it on a little bit faster. There will be always be part of it. This year is probably going to be our peak CapEx number, '26 and '27 are probably going to be the peak year for CapEx, $3.5 billion this year. somewhere around that, maybe slightly lower next year as we get into '27, but that was sort of our expectation. '26 to '27 will be peak years.

Fantastic. If we could just switch to the audience response questions here first. All right. So when the timer goes on, that's when to respond. Do you currently own the stock? Yes, overweight, market weight, underweight or no? Timer, please. Okay. Lots of dry powder. About half the room that says no. Next question? What is your general bias towards the stock right now, positive, negative or neutral? Half the room -- a little over half the room says positive. Next question, please. In your opinion, through cycle EPS for CAT will be above peers, in line or below peers? All right, about 2/3 of the room, above peers. Next question, please. In your opinion, what should CAT do with excess cash, both on M&A, larger M&A, repos, DVs, debt pay down or internal investment? Buy back shares, Andrew. Next question. And the last one, and this one is not going to be a good one for this room. In your opinion, on what multiple of '26 earnings should CAT trade, less than 10x, all the way above, higher than 21x? You guys can mess with us here. All right. I'm going to throw that one now. But it's -- I led to the witness -- all right. So maybe just Andrew, just to pass back to you. Anything you want to wrap up with here?

No, just -- obviously, this is an incredibly exciting time to be at Caterpillar. There's lots of opportunity. Our focus is, again, still continuing to drive strong total shareholder return. We're very pleased with the returns we've been able to drive for shareholders. But that is obviously part of the strategy is to continue to do that going forward. That's the most important thing.

Excellent. Well, please join me in thanking Andrew, Rob and Alex for coming here.