Caterpillar’s Net Rises On Cost Cuts, But Mining Weakness Likely To Persist Through 2014

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Caterpillar‘s (NYSE:CAT) earnings rose by 5% annually in the second quarter, even as its revenues fell by 3% annually due to continued weakness in the global mining sector. [1] The maker of mining and construction equipment was able to grow its profits even as its top line declined, as gains from the company’s cost cutbacks and its construction equipment growth outweighed the impact from mining weakness. Caterpillar (CAT) also announced in its earnings release that it will buyback shares worth $2.5 billion during the third quarter. [1] The company cited its strong balance sheet and solid cash flow from operations while announcing this decision. We had recently written on how CAT’s strong balance sheet will enable it to endure the ongoing mining sector weakness. Additionally, buoyed by its healthy profit growth in the first half of this year, CAT raised its 2014 earnings guidance to $5.75 per share, from $5.55 per share it announced earlier. In our view, a significant portion of the company’s 2014 earnings growth will come from its share buybacks, which by lowering CAT’s share count will help grow its per share earnings. In the first quarter of 2014, CAT bought back $1.7 billion of its stock and by the end of the third quarter, the company plans to repurchase $4.2 billion of its stock. These repurchases are part of the $10 billion stock repurchase program that CAT finalized in the first quarter of this year. [1]

We currently have a stock price estimate of $109 for CAT, marginally above its current market price. We are in the process of incorporating CAT’s second quarter results and shall update our analysis shortly.

See our complete analysis of CAT here

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Mining Sector Weakness Impacts Top Line

In the second quarter, CAT’s mining segment sales fell by 29% annually due to lower equipment demand from the global mining sector. [1] For over a year now, CAT has battled weak demand for machinery and equipment from the global mining sector. As mining companies have slashed their costs and capital spending after incurring large asset write-offs, sales of mining equipment manufactured by CAT have tanked. In 2013, the company’s mining segment sales fell by 37% annually. And, in the first quarter of this year, they fell by 33% annually. What is encouraging here is that the declines in CAT’s mining segment sales are progressively moderating.

The company also said that even though its mining machinery part sales in the second quarter were lower than that in the previous year quarter, but they were higher than that in the first quarter of 2014. CAT also said that it continues to see weak order inflows for new mining machinery from mining companies, and, that equipment investments by mining companies such as Vale, Rio Tinto and BHP Billiton will likely be lower in 2014, compared to 2013. Thus, a recovery in CAT’s mining segment sales is unlikely in 2014. On a year-over-year basis, CAT anticipates its mining segment sales to fall by 20% in the current year.

Growth In Construction Equipment Sales Driven By North America

On the bright side, the decline in CAT’s second quarter mining sales, was partially offset by higher sales from its construction equipment segment. CAT’s sales from this segment rose by 11% annually in the second quarter on higher demand from North America. Looking ahead though, the company expressed concern about the softening construction spending from China. In the first half of 2014, construction machinery sales in China remained soft due to China’s actions to slow credit growth that contributed to a decline in the country’s property market. As CAT has significant dependence on China’s construction industry, softening demand from that market also forced the company to lower the high end of its 2014 top line guidance. The company had earlier forecast its 2014 top line to lie in a range of $53.2-58.8 billion, but now the company anticipates its top line to lie in the range of $54-56 billion. [1] All in all, after the significant drop in its results in 2013, CAT’s sales and earnings outlook for 2014 is flat on a year-over-year basis.

Cost Cuts Will Likely Continue

Separately, CAT said that its cost cutbacks will continue over the coming months. At the end of the second quarter, the company’s employee headcount was approximately 131,600, around 6,700 lower than that at the end of the second quarter of 2013. [1] Apart from headcount reduction, CAT is also consolidating plants that ensures greater sharing common resources. We figure these cost reduction measures are essential for CAT to grow its profits in the current tough macro environment. And, even over the long term, higher margins driven by these cost cutbacks will enable the company to boost its competitive position, as higher margins enable aggressive pricing.

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Notes:
  1. CAT’s 2014 Q3 earnings form 8-K, July 24 2014, www.caterpillar.com [] [] [] [] [] []