Caterpillar Is Cutting Costs In An Attempt To Protect Profits From Weak Demand

by Trefis Team
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Caterpillar (NYSE:CAT) is facing a tough environment with significantly lower demand from the global mining industry. In its most recent dealer statistics, the company reported that sales of mining and construction machinery by its dealers fell by 12% annually and engines and turbines by its dealers fell by 9% annually in the three month ended October 31, 2013. [1] This ongoing decline in the company’s end user sales is largely due to sharply lower capital spending from mining companies which have seen many asset write-offs in the recent past. Additionally, weak demand for many commodities and metals is also prompting mining companies to cut back on capital spending. In turn, this decline in spending from the mining sector is impacting Caterpillar severely, as the company gets around a third of its business from the mining sector.

In all, in the first three quarters of this year, Caterpillar’s sales fell by 18% annually in large part due to a 33% year-over-year fall in its mining sales. [2] This dismal performance is also not likely to improve in the near future, as in its third quarter earnings filing, Caterpillar forecasted its mining sales to not recover in 2014. The company said this on the basis of weak order inflows, which render a recovery in sales unlikely in the near term.

Thus, in the absence of top line growth, the company is resorting to deep cost cuts in an attempt to protect its profits. We currently have a stock price estimate of $88.43 for Caterpillar, around 5% ahead of its current market price.

See our complete analysis of Caterpillar (CAT) here

Caterpillar Cut Operating Costs By $5 Billion In the First Three Quarters

In the first nine months of this year, CAT slashed its operating costs by over $5 billion or 12% on a year-over-year basis. [2] The company reduced its workforce – full-time and flexible – by over 13,000 employees to 137,000 employees at the end of the third quarter, compared to last year. [3] CAT also reduced its research and development expenses by 15% annually and its selling, general and administrative costs significantly through across the board austerity measures. The company also shut down many plants temporarily and plans to halt production at other plants in an effort to further clamp down on costs. These cuts have ensured that the company’s profits do not bear the full impact from lower demand on sales. However, in the year to date period, these cuts have been only partially successful in offsetting the $8.5 billion or 18% y-o-y fall in Caterpillar’s sales. [2]

On the whole, we figure these cuts have helped save the company’s profits from declining to a large extent, but in light of the ongoing weakness in the global mining industry, these cost cuts will likely have to continue for the foreseeable future. At the same time, we continue to expect strong long term growth from the mining sector driven by rising demand for energy, metals and commodities from the emerging countries.

Additionally, if the recent past is anything to go by then we understand that demand from mining sector can change very quickly like the sudden rise in mining demand in 2010 in the aftermath of the financial crisis. Due to such a possibility, although CAT is slashing its costs, it is not reducing its capacity substantially so that it can respond quickly when market conditions improve. Separately, we also expect the company’s strong balance sheet and cash flow from operations to help it wade through this current period of industry weakness. (See Caterpillar’s Strong Balance Sheet And Cash Flow Support Its Outlook Despite Industry Weakness)

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Notes:
  1. Caterpillar dealer statistics for three months rolling ending October 2013, November 20 2013, www.caterpillar.com []
  2. Caterpillar’s 2013 Q3 10Q, November 1 2013, www.caterpillar.com [] [] []
  3. CAT’s 2013 Q3 earnings form 8-K, October 23, 2013, www.caterpillar.com []
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