Weaker Demand Will Dig Into Caterpillar’s Earnings

by Trefis Team
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    Quick Take
  • Weak demand from the global construction markets is impacting Caterpillar’s construction equipment and machinery sales.
  • As a result, the company is reducing its production rates which is hurting its profits due to increased manufacturing costs caused by inefficiencies.
  • Additionally, declining coal production in the U.S. is impacting Caterpillar’s mining equipment sales.
  • We anticipate the demand for Caterpillar’s products to improve towards the end of 2013 and early 2014 with the recovery in global construction markets.

Caterpillar (NYSE:CAT) will announce its first quarter earnings on Monday, April 22. The maker of construction and mining equipment will likely post lower sales and profits due to weakness in the global construction markets and declining coal production in the U.S.

The company anticipates the demand environment in its key markets to improve as the year progresses. For full year 2013, it forecasts sales between $60 billion and $68 billion compared to $65.8 billion in 2012, and earnings between $7 and $9 per share compared to $8.48 per share in 2012. [1] [2] The wide range of the forecasts highlights the current level of uncertainty that Caterpillar (CAT) faces in its key markets.

We currently have a stock price estimate of $94 for the company, approximately 10% above its current market price.

See our complete analysis of CAT here

Weak Global Construction Equipment Demand

The production of steel, which is a key input material for construction, is usually a good indicator of the construction industry’s health. In February, world crude steel production declined by nearly 5% to 123.3 million tonnes, according to the World Steel Association. [3] Steel production declined across major steel producing countries including China, Japan, the United States and India. This indicates a weak growth environment in the global construction markets where Caterpillar’s construction equipment sales will likely decline in the first quarter.

This low-end user demand is forcing Caterpillar dealers to reduce their inventory levels, which is further impacting sales of the company. Additionally, in light of the suppressed purchase activity from the dealers, Caterpillar is lowering its production rates. The cost impact from these lower production rates is impacting the company’s profits.

The construction industry segment constitutes around 20% of Caterpillar’s value according to our analysis.

Declining Coal Production In The U.S. Is Impacting CAT’s Mining Equipment Sales

Also, lower coal production in the U.S., driven by a shift towards cleaner sources of electricity production, is hurting Caterpillar’s mining equipment sales in the country. The impact from this shift is severe as the coal mining industry alongside iron ore mining is one of the largest consumers of Caterpillar’s mining equipment. Coal production in the U.S. had declined through 2012, and in the first quarter of 2013, it declined 9.3% year-over-year to 240.3 million short tons, according to the U.S. Energy Information Administration. [4] [5] We anticipate this decline in coal production to impact Caterpillar’s original equipment and aftermarket mining equipment sales. In 2012, Caterpillar generated nearly 30% of its mining equipment sales from North America, a majority of which came from the United States. [1]

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Notes:
  1. Caterpillar’s 2012 10-K, February 19 2013, www.caterpillar.com [] []
  2. Fourth quarter and full year 2012 earning results – Form 8-K, January 28 2013, www.caterpillar.com []
  3. World steel association – monthly crude steel production statistics, April 11 2013, www.worldsteel.org []
  4. U.S. Energy Information Administration – Quarterly Coal Report, April 11 2013, www.eia.gov []
  5. U.S. Energy Information Administration – Weekly Coal Production, April 11 2013, www.eia.gov []
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