CAT Unearths Accounting Fraud in ERA - Analyst Blog
21 Gennaio 2013 - 12:10PM
Zacks
In a shocking development,
Caterpillar Inc. (CAT) announced that it has
unearthed accounting misconduct at its recently acquired company
ERA Mining Machinery Limited (ERA) as well as its subsidiary
Zhengzhou Siwei Mechanical & Electrical Manufacturing Co., Ltd.
(Siwei).
Financial Impact &
Impact on Shares
Following the discovery of the
fraud, Caterpillar will incur a charge of approximately $580
million (87 cents per share) in the fourth quarter scheduled on Jan
28. Caterpillar, however, added that it will not have a significant
impact on 2013 revenue or profit. With the break of this news,
Caterpillar stock price fell 1.5% at $96.11 in late
trading.
A Brief Background of the
Acquisition
In a bid to strengthen its
presence in the Chinese mining industry, Caterpillar had announced
its intention to acquire ERA in November 2011. ERA primarily
engaged in the designing, manufacturing and supporting underground
coal mining equipment in China through its wholly owned subsidiary,
Siwei.
Siwei possesses a manufacturing
base of 600,000 square meters in Zhengzhou, Henan province, where
it manufactures and sells roof support equipment to underground
mining customers in China. In June 2012, Caterpillar closed the
deal after receiving a go-ahead from the Ministry of Commerce of
the People’s Republic of China (MOFCOM).
Findings of the
Investigation
The issue first came to the fore
when discrepancies were identified in November last year between
the inventory recorded in Sewer’s accounting records and the actual
physical inventory. Caterpillar immediately initiated a
comprehensive review and investigation.
The investigation revealed that
inappropriate accounting practices were being carried out for a
number of years prior to Caterpillar’s acquisition of Siwei. This
included improper cost allocation that resulted in overstated
profit and also improper revenue recognition practices involving
early and, at times unsupported, revenue recognition. Several Siwei
senior managers had been identified involved in the
malpractices.
Corrective Measures
Taken
Caterpillar has removed the
erring senior managers and a new leadership team has been put in
place. The responsibilities for Siwei manufacturing operations have
been shifted to Caterpillar’s China Operations Division, which will
now report to Kebao Yang, Caterpillar Global Mining General Manager
for China and Korea.
Our View
Despite this setback, Caterpillar
believes that the Siwei acquisition is well aligned with its
strategy to expand its role as a leading equipment and solutions
provider for the Chinese coal mining industry. Caterpillar
continues to systematically strengthen its business in China and
remains committed to providing the lowest owning and operating
costs in the industry.
However, signs of a slowdown in
China have triggered concerns lately as it will have a negative
effect on infrastructure and construction spending. This will in
turn negatively impact on Caterpillar’s sales in the near term.
Furthermore, the company faces risks from a global economic
slowdown and the expansion of big Chinese companies in the
international arena. Furthermore, the slip on part of the
management in not identifying the accounting problem will weigh on
the shares in the near term.
Peoria, Illinois-based
Caterpillar Inc. is the manufacturer of construction and mining
equipment, diesel and natural gas engines, and industrial gas
turbines. The company is one of the few leading U.S. companies in
an industry that competes globally from a principally domestic
manufacturing base. Caterpillar operates two divisions – Machinery
and Power Systems and Financial Products. Caterpillar currently
retains a Zacks Rank #4 (Sell). Joy Global, Inc.
(JOY), H&E Equipment Services Inc. (HEES) and
The Manitowoc Company, Inc. (MTW) retain Zacks
Rank #3 (Hold) in the same industry.
CATERPILLAR INC (CAT): Free Stock Analysis Report
H&E EQUIP SVCS (HEES): Free Stock Analysis Report
JOY GLOBAL INC (JOY): Free Stock Analysis Report
MANITOWOC INC (MTW): Free Stock Analysis Report
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