Caterpillar’s Earnings Preview: Revenue And Profits Could Decline On Poor Mining And Construction Sales

Caterpillar (NYSE:CAT) will announce its second quarter earnings Thursday, October 23. The maker of mining and construction machinery is coming off a good second quarter in which despite a decline in revenue, its profits rose on gains from cost reduction activities. In the third quarter, we expect to see a decline in Caterpillar’s (CAT) revenue driven by continued weakness in the Resource Industries segment accompanied with poor Construction Industries sales. Engine and Transportation segment sales will likely get offset by a decline in its mining and construction machinery sales. The company’s third quarter profits will likely decline despite its cost reduction activities.

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Global mining weakness to weigh on CAT’s revenue

CAT has been struggling due to weak demand for machinery and equipment in the global mining sector since the fourth quarter of 2012. CAT’s revenue from its Resource Industries segment, which primarily comprises of sales of mining equipment and machinery, has been declining due to profitability improvement programs at mining companies. Large asset write-offs in late 2012 and 2013, forced mining companies such as Vale, Rio Tinto and BHP Billiton, to cut costs and reduce capital spending. This significantly reduced demand for mining equipment and led to a 37.3% year-on-year decline in CAT’s Resource Industries’ revenue for 2013. ^[1] The after affects of the 2013 asset write-offs and low mined commodity prices have kept the demand for mining equipment and machinery suppressed in 2014. Declining prices of mined commodities such as coal and iron ore, driven by high production and slowing demand from China, have discouraged mining companies from investing in new mines or expanding operations. CAT’s Resource Industries’ revenue continued to suffer due to this trend in the first half of 2014. In the second quarter of 2014, Resource Industries revenue contracted by 28.5% year-on-year. ^[2]

We anticipate this weakness from the global mining sector to persist through the second half of the current year. CAT’s recent retail sales data seems to corroborate our expectations. In August 2014, retail sales for its Resource Industries products were down 33% globally, with all geographies showing negative growth. ^[3] It is encouraging to note that the declines in CAT’s mining segment sales have progressively moderated. After falling 37% last year, the company’s mining segment sales decline moderated to 33% year-over-year in the first quarter and to 29% in the second quarter. For full year 2014, CAT forecasts its mining segment sales to contract by 20% annually, ^[4] which points towards further moderation in the second half of the year.

Weak construction sales to add pressure on top line

In the past two quarters, sales of construction machinery have been able to partially cushion the decline in mining equipment sales. However, this may be absent in the third quarter. The weak Brazilian economy and tough year-on-year comparison with Latin American markets has taken a toll on CAT’s Construction Industries segment. According to CAT’s retail statistics for August, global retail sales were down 1%, with only North American markets posting positive growth. Sales to Latin American markets declined 23%. ^[3] In the previous year, CAT had received large orders from Brazil’s government which had significantly increased sales, leading to tough comparisons for this year’s third quarter. In addition, the economic condition in Brazil has been particularly troublesome in 2014 due to the recession brought on by declining investments in the country. Investments in Brazil contracted 5% due to the poor business environment and uncertainty ahead of the elections. ^[5]

The only way CAT would have been able to generate positive growth in construction equipment sales is if its dealer would have restocked their inventories. However, given the current macroeconomic conditions it seems highly unlikely. We therefore expect to see declines in CAT’s Construction Industries segment, which will add to the headwinds presented by the Resource Industries segment.

Despite cost cuts, profits to decline on weak mining and construction sales

In an attempt to lower its operating costs, CAT has been undertaking cost reduction measures since early 2013. These measures include plant consolidations, which ensure greater sharing of common resources, and headcount reductions, which save salary costs. This enabled CAT to lower its operating costs by $7 billion in 2013 and by $0.5 billion in the first half of 2014. ^[1] During the recent earnings meet, CAT announced that it will continue with its cost reduction measures in the coming months. However, given the decline in sales of mining and construction equipment, CAT’s third quarter profits might take a hit, despite the cost cuts. Consensus estimates for the third quarter earnings per share are at $1.33, 8.3% lower than the previous year’s third quarter. ^[6] The consensus earnings per share estimate, which most likely has taken into account the planned $2.5 billion share repurchase in the third quarter, also points towards a decline in profits.

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1. CAT’s 2013 Q4 earnings form 8-K, January 28 2014, www.caterpillar.com [↩] [↩]
2. CAT’s 2014 Q2 10-Q SEC Filing, April 2014, www.sec.gov [↩]
3. CAT’s Monthly Retail Statistics, www.cat.com [↩] [↩]
4. CAT’s 2014 Q1 earnings form 8-K, April 24 2014, www.caterpillar.com [↩]
5. Brazil Goes Into Recession for First Time in Over 5 Years, August 29, 2014, www.bloomberg.com [↩]
6. Caterpillar Inc Estimates, www.earningswhispers.com [↩]