Caterpillar (NYSE:CAT) will announce its third quarter earnings on Monday, October 22. The company has forecast revenues in the range of $68-$70 billion and earnings per share (EPS) of $9.60 for the full year 2012.  This compares to revenues of $60.1 billion and EPS of $7.64 in 2011.  For the six months ended June 30, 2012, the company was able to achieve revenues of $33.4 billion and EPS of $5.04.  This shows that Caterpillar’s performance in the first half of 2012 has been impressive and it seems on target to meet its full year earnings forecast.
However, over the past few months, declining mining activity worldwide due to a decline in prices of iron-ore and key base metals has posed the single-largest challenge to Caterpillar’s growth momentum. In addition, the continuing slowdown in Europe is expected to impact growth across its industrial businesses: mining, construction and power systems. On the bright side, the monetary easing in Brazil and lower interest rates in China along with the announcement of a slew of infrastructure projects in the country will add to the growth in Caterpillar’s construction business.
On the whole, Caterpillar’s earnings for the third quarter will post moderate growth due to the impact of declining mining activity worldwide. We currently have a stock price estimate of $95.44 for the company, nearly 15% above its current market price.
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Declining mining activity worldwide
Iron-ore prices have declined from $178 per metric ton in September 2011 to $99 per metric ton in September 2012.  Copper prices also have remained weak in the third quarter of this year.  As a result, investment in mining activity has declined as mining companies are getting lower prices for their output. Several mining companies have lowered or are planning to lower their spending in the near term.
Australian iron-ore producer Fortescue Metals Group (FMG) recently cut its full-year capital expenditure by 26% to $4.6 billion. BHP Billiton, the world’s largest mining company, has delayed projects worth $68 billion, and Vale (NYSE:VALE) plans to cut its spending by 4% in 2013.  This has resulted in a decline in orders for mining equipment and machinery manufactured by Caterpillar. And, as mining business constitutes nearly 42% of Caterpillar’s total value, the decline in mining investment will likely impact the company significantly in the third quarter.
Easing monetary policy in Brazil and China add to growth
On the brighter side, as inflation rates have eased in Brazil and China, their central banks have lowered interest rates, which is boosting investment and growth. Both markets constitute a significant portion of Caterpillar’s overall value. Brazil lowered its interest rates in late 2011 and sales in construction business of the company have shown an improvement in the country since.
China has lowered its interest rates only recently so the full effect on the company’s growth will be visible in late 2012 and 2013.  China has also announced a slew of infrastructure projects with a total estimated spend of $134 billion.  This increase in spending will have a positive effect on Caterpillar’s third quarter results.
Higher profits for Caterpillar Financial
Caterpillar Financial, the wholly-owned subsidiary of Caterpillar that promotes the sale of Caterpillar products by providing financing alternatives, has been witnessing higher margins on account of lower credit losses. The subsidiary has been steadily reducing its exposure to risky assets post the financial crisis and increasing the proportion of higher quality assets such as financing receivables and operating leases at constant rates. This has resulted in a higher net yield on average earning assets and improved margins for the company. We anticipate this trend will continue to aid margin growth in the third quarter.
Overall, Caterpillar’s strong growth in the first half of 2012 is expected to moderate in the third quarter due to the impact of declining mining activity worldwide. However, the improving growth environment in emerging countries such as Brazil and China will partially offset this impact.Notes:
- Caterpillar Reports Best Quarter in History and Raises 2012 Profit Outlook, July 25 2012, www.caterpillar.com [↩]
- 2011 10-K, www.caterpillar.com [↩]
- 2012 Q2 10-Q, www.caterpillar.com [↩]
- Iron Ore Monthly Price – US Dollars per Dry Metric Ton, www.indexmundi.com [↩]
- Copper price graphs, www.lme.com [↩]
- GE Sees Sales Entry as Miners’ Cutbacks Hit Caterpillar, September 25 2012, www.bloomberg.com [↩]
- China inflation rate dips to a 30-month low in July, August 9, 2012, www.bbc.co.uk [↩]
- Caterpillar’s Stock Digs Up Gains On China’s New Stimulus, September 12 2012, www.trefis.com [↩]