Caterpillar‘s (NYSE:CAT) 2013 results were severely impacted by mining sector weakness. The company’s revenues contracted by 16% annually to $55.7 billion due to reduced spending by mining companies on new machines and equipment purchases.  Additionally, throughout 2013, CAT’s mining related after market machine part sales were impacted as mining companies delayed maintenance and repairs on their fleets in an attempt to lower their operating costs. This weakness from the mining sector weighed heavily on CAT as it generated nearly a third of its business from this sector.
However, looking ahead, there’s some cheer for CAT as certain trends in the mining sector point towards a recovery. Right now, mining companies are working their newer machines more hours at the expense of their older machines, which typically require more frequent part replacements and repairs. Eventually, these companies will have to undertake aftermarket machine part purchases in order to prevent their machines from downtime. Accordingly, Caterpillar currently estimates its mining related aftermarket machine part sales to level off in 2014 after declining through 2013.
Additionally, mine production and consumption of commodities such as coal and iron ore continue to grow and is expected to rise through 2014 based on improving global economic growth. We figure this trend will also increasingly compel mining companies to resume new machine purchases. On its part, CAT estimates its mining segment sales to contract by 10% in 2014, from 2013.  However, these trends of lower than normal levels of aftermarket machine part purchases by mining companies and steadily growing mine production will, in our opinion, lead to recovery in the mining sector. The essential question therefore is when this recovery will take place.
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It is here that we figure an analysis of mining sector’s recent past can prove helpful. In early 2009, outlook for the global mining sector was bleak due to the downturn brought about by the global financial crisis. By 2010, this bleak outlook turned positive driven due to the recovery in the global economy. It remained positive through 2011 and early 2012, where after it turned bleak again due cost and capital controls initiated by many mining companies after incurring large asset write-offs. The sector continued to see a downcycle through 2013 as mining companies lowered their capital investments in machines and equipment, but right now backed by trends outlined above, we figure that recovery in the sector is in sight. These past few years illustrate that mining sector’s outlook can change pretty rapidly. So, if not by 2014 end, then mining sector could see recovery in early 2015.
Caterpillar’s fourth quarter results also exceeded expectations reflecting a bottoming out mining sector. The company’s profits grew by 5% annually in the quarter after falling steadily for the past many quarters. 
We currently have a stock price estimate of $88.43 for CAT, around 5% below its current market price.
Long Term Growth Factors For The Global Mining Sector Persist
Caterpillar’s exposure to the mining sector increased in 2011 after its $8.8 billion acquisition of Bucyrus. The weakness that followed this sector over the next couple of years makes the acquisition seem like a case of bad timing, but in our view, long term fundamentals that support growth in the mining sector remain intact. Enormous demand potential for energy and infrastructure remains in the emerging countries of Asia-Pacific and Latin America that requires mined commodities such as coal and iron ore. Thus, as emerging countries continue to add power generation capacities and build physical infrastructure, demand for machines and equipment that enable mining will recover.
Focus On Returning Capital To Shareholders Boosts Confidence In The CAT Stock
Additionally, even during this period of weakness, CAT’s focus on returning significant capital to its shareholders through dividends and share buybacks eases their concerns and indicates that management is confident about a strong future for the company. Recently, CAT announced that it completed share repurchases worth $1.7 billion in the first quarter and authorized an additional $10 billion for share repurchases through 2018.  The company also paid a dividend of 60 cents a share last quarter which translates to an annual yield of around 2.5%.
Separately, the remaining two third of CAT’s business – construction and power systems – are doing better. In the current year, the company anticipates its sales from both these segments to rise by around 5% annually driven by growing construction market in China and recovering housing market in the US. An early recovery in the global mining sector will support growth from construction and power systems segments to boost the company’s results.Notes: