Cost Cuts Could Lift Caterpillar’s Earnings Despite Mining Weakness

Caterpillar (NYSE:CAT) will announce its first quarter results Thursday, April 24. The maker of construction, mining and power equipment is coming off a very challenging 2013 in which its revenues contracted by 16% annually to $55.7 billion and its earnings fell by 32% annually to $5.75 per share due to mining sector weakness. ^[1] Throughout 2013, demand for mining equipment and machinery such as mining trucks, wheel loaders, shovels, boring equipment etc. remained weak as mining companies cut capital spending after incurring several asset write-offs. With mining sales constituting around a third of Caterpillar’s (CAT) total business, this severe decline from the sector weighed on the company’s overall results.

In the first quarter, we anticipate CAT’s results to continue to be hit by this weakness from the global mining sector. Mining companies continue to reduce their cost and capital spending in order to shore up their profits. This in turn is keeping demand for mining equipment low. In its outlook for full year 2014, CAT forecasts its mining sales to fall by around 10% annually. However, the company also anticipates this decline in its 2014 mining sales to be offset by moderate growth from its other businesses namely construction and power systems. ^[1] We figure in the first quarter, CAT’s top line could decline slightly due to mining sector weakness offsetting growth from construction and power system segments. However, we figure the company’s first quarter profits will likely rise despite mining sector weakness on gains from cost reduction measures.

We currently have a stock price estimate of $97.56 for CAT, around 5% below its current market price.

See our complete analysis of CAT here

Mining Sector Weakness Will Weigh On CAT’s First Quarter Revenues

Many mining companies incurred large asset write-offs in the recent past, while some others witnessed management changes. These events coupled with weak prices for many commodities forced many mining companies to slash their capital spending. This decline hit CAT’s mining machinery and equipment sales. The company’s aftermarket sales of mining machinery spare parts was also hit due to mining companies cutting their operating costs. One of the ways in which mining companies have been lowering their expenses is by working their newer machines more hours at the expense of their older machines, which typically require more frequent part replacements and repairs.

Additionally, in its most recent dealer sales statistics, CAT reported that sales by its dealers in its resource industries segment (which largely consists of its mining business) fell in double digits on a year-over-year basis for the three months ended February 28, 2014. This decline was led by a 55% year-over-year drop in mining machinery sales from the Asia-Pacific region followed by Latin America where they fell by 49% annually. Overall, for the three month period ended February 28, 2014, mining machinery sales by CAT dealers to end users such as mining companies fell by 37% annually. ^[2] So, we figure that CAT’s mining sales will likely decline in the first quarter.

Cost Cuts Will Likely Protect First Quarter Profits

To combat this weakness from the global mining sector, CAT is slashing its costs. Last year, the company lowered its operating costs by more than $7 billion to mitigate the negative impact from weakness in the global mining sector. It reduced its workforce – full-time and flexible – by around 9,700 employees during the year to around 133,000 employees at the end of 2013. The company also slashed its research and development costs by 17% annually, and its selling, general & administrative costs by 6% annually through across the board austerity measures. ^[1] CAT also shut down many plants to further clamp down on its costs. These cost reduction initiatives remain underway currently. And, we figure in the first quarter, gains from these large scale cost cutbacks will protect CAT’s profits from the decline in its mining sales.

Construction & Power Businesses Are Likely To Post Better Results

Additionally, the remaining two-third of CAT’s business – construction and power system equipment sales – is doing much better. Results from these two segments are likely to show moderate growth in the first quarter, in line with their full year guidance provided by CAT. In our view, higher profits from these two segments aided by cost cuts will likely more than offset the decline in the company’s mining profits. So, overall the first quarter results could mark the beginning of stabilization for CAT after more than a year of decline.

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1. CAT’s 2013 Q4 earnings form 8-K, January 28 2014, www.caterpillar.com [↩] [↩] [↩]
2. CAT’s monthly retail statistics, April 22 2014, www.caterpillar.com [↩]