Caterpillar leans on old playbook to cope with tariffs

Six months into the US tariffs on imported aluminium and steel, Caterpillar Inc is finding that one of the best ways it can protect profits is a costcutting strategy that is more than two years old. At this sprawling factory in central North Carolina where it makes small front-end loaders, the company laid off workers in 2016 in response to plunging sales, consolidating two shifts into one under a programme it calls the Operation and Execution Model.

Even though demand has picked up since then, its Clayton plant still runs a single shift and operates only four days a week. One third of the facility’s 550 employees are on flexible contracts.

The result: CAT is producing more loaders here with 30 per cent fewer people on the factory floor than in the past, the company said.

It has redesigned all new machines it makes with over 20 per cent fewer parts, cutting back on the consumption of steel which brings down the cost, Tony Fassino, vice-president at Caterpillar’s building construction products, said after a factory tour in Clayton.

“Fewer parts numbers are a huge win,” Fassino said. “It improves safety, it improves the quality, it improves the cost.”

Now, these cost-cutting approaches are helping counter the financial impact of US President Donald Trump’s trade wars.

The heavy-duty equipment maker estimates the import tariffs will inflate its raw materials costs by up to $200 million between July and December, though it does not provide a forecast for manufacturing costs in 2018. Caterpillar has said it would offset the impact through a price increase that went into effect on July 1 and general cost-cutting measures, helping it post a record profit for all of 2018.

Caterpillar’s increasing emphasis on operating efficiency has proven timely, helping to bring down the cost of production at a time when material expenses are mounting on Trump’s import curbs, and capacity constraints are driving up freight costs.

An internal calculation provided to Reuters, previously unreported, shows that the measures have accounted for half of the improvements in the profit margins since 2015 at the company’s construction industries division. Since January 2017, the efficiency model has been rolled out across the company, but CAT would not disclose more details.

CAT, Deere & Co and Harleydavidson Inc are among the many manufacturers trying to keep a lid on expenses to cope with a 30-per cent rise in US steel prices since the start of 2018. Those rising costs, along with a tit-for-tat tariff war with China, have clouded the earnings outlook for industrial companies, dragging down their shares.

Despite a recent rally this month, Caterpillar shares are down about 9 per cent from their late-january levels, compared with a 0.4 per cent decline in S&P 500 industrials index, showing investors have yet to fully reward the company for its industrybest efficiency results when it comes to operating margins and return on net operating assets.

Steve Volkmann, a machinery analyst at Jefferies, attributes the stock’s underperformance to concerns that the company’s greater exposure to foreign markets and a sizeable presence in China make it more vulnerable to escalating trade wars.

“It is disappointing that they can’t get paid for good quarters these days,” he said, referring to the company’s strong earnings in the last quarter.

While overseas markets do account for more than half of Caterpillar’s sales, the company has an evenly spread manufacturing footprint across the globe, which Volkmann and other analysts say make it better placed to deal with the tariffs.

The company has also tried to put at rest worries about its operations in China, saying the trade tensions have not impacted its business there.

As part of its cost-cutting effort, CAT business heads have been mandated to reduce the overall manufacturing cost of every new product by at least 5 per cent, one Caterpillar company executive said. This entails cost cuts by suppliers as well.

Donaldson Company Inc — which makes filters for CAT’S machines — said that it tries lower the cost of production every year through material substitution or automation or efficiency gains. Cuts in travel and entertainment budgets helped the company improve operating income by 40 basis points in the latest quarter.

CAT’S Operation and Execution effort affects both production strategy decisions and small details of every operation.