Caterpillar (NYSE:CAT) faced a very challenging 2013 due to weak global demand for mining machinery and equipment, which constitute around a third of the company’s business. In the first nine months of this year, the company’s sales fell by 17% annually or $8.5 billion with the largest portion of this decline coming from its mining segment. Over this time period, CAT’s mining machinery and equipment sales fell by around 33% annually or $5.4 billion due to weak end user demand from mining companies which lowered their machine purchases in order to control cost and capital spending.  Caterpillar dealers also slashed their inventories due to this weak end user demand which further impacted the company’s sales.
Looking ahead, even though it is likely that global economy will grow faster in 2014, compared to 2013, the demand environment in CAT’s end markets particularly mining will likely continue to remain soft at least through early 2014. Accordingly, the company forecasts its 2014 sales to remain flat, compared to 2013, with growth from its construction equipment sales offset by additional decline in its mining equipment sales.
We currently have a stock price estimate of $88.43 for Caterpillar, marginally below its current market price.
Mining Sector Will Likely Remain Soft In The Near Future
Caterpillar continues to see weak order inflows from its mining customers, and at the same time, its dealers continue to slash their inventories. As the company sells its products to its dealers who in turn sell them to end users like mining and construction companies, it is open to impact from fluctuations in its dealer inventories. Anticipating weak demand from end users, CAT dealers are continuing to slash their inventories. At a recent conference, the company indicated that its dealers could continue to slash their inventories through early 2014, which would add to the impact from weak end user demand and weigh on its 2014 results. However, in our opinion, the company will unlikely see dealer inventory reductions of the scale it saw in 2013, as its dealer inventories are already quite low. In all, weak order inflows and dealer inventory reductions will likely continue to dig in to CAT’s results at least through early 2014.
CAT’s Mining Sales Are Difficult To Forecast
Separately, the recent past shows that demand from the mining sector can change very rapidly. This makes it difficult to forecast CAT’s mining sales. In early 2013 for instance, when CAT announced its full year sales outlook, it took in to account the low order rates from mining companies at the time to forecast lower year-over-year mining sales, but seeing strong production statistics for most mined commodities, it anticipated order rates to pick up through 2013. Instead, as the year progressed mining companies continued to focus on optimizing usage of their existing machines in order to lower their operating costs. This forced CAT to lower its full year 2013 guidance at the end of the third quarter to sales of $55 billion and earnings of $5.50 per share, down from sales of $66 billion and earnings of $8.48 per share last year. 
According to CAT, one of the ways in which mining companies are lowering their operating costs is by working their newer machines extra hours at the expense of older machines, which require more frequent parts replacement. This is allowing mining companies to postpone purchases of machine parts. However, at some point mining companies will have to incur machine part purchases which will increase aftermarket machine part sales of CAT. Additionally, production statistics for many mined commodities continue to remain healthy which indicates that equipment orders from mining companies could rise in the coming months.
Construction & Power Systems Segments Will Perform Relatively Better In 2014
CAT’s remaining businesses – construction and power system segments – are likely to hold up better than its mining segment in 2014. The company’s construction equipment and machinery sales could rise slightly in 2014 driven by recovering construction spending from the US and Europe, while it anticipates its power system sales to remain flat in 2014.
In the long term, we figure that demand for CAT’s construction and mining equipment, diesel and natural gas engines, industrial gas turbines and diesel-electric locomotives will recover driven by growing global demand especially from the emerging countries for energy and infrastructure development. Trends like rising middle class population and urbanization in the developing countries will grow demand for energy, roads, rails, buildings and other infrastructure, all of which require products which are manufactured by CAT.Notes: