Is Caterpillar’s Mining Equipment Business Turnaround In Sight?

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Caterpillar (NYSE:CAT) has been suffering from weak mining equipment sales, as mining companies have reduced capital spending in terms of purchasing new equipment or spare parts as a result of huge asset write-offs and declining commodity prices. Caterpillar’s Resource Industries revenue declined 37.3% year-on-year in 2013 and 27% in the first nine months ended September 30, 2014. However, Caterpillar seems to be optimistic regarding the near future. At a recent conference, the company stated that it was working towards building up ‘strategic inventory’ of its mining equipment. [1] Does this mean that it’s Resource Industries business will turn around soon?

See our complete analysis of CAT here

What is Strategic Inventory?

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Caterpillar is building an inventory of components and machines that are more likely to see high demand once the mining equipment market turns around. Given that in the past, demand for equipment and machinery from the mining industry has been quite volatile, building up an inventory of components and machines that generally have higher lead times will help Caterpillar cater to the rejuvenated demand at the earliest. The reason why Caterpillar decided to build up ‘strategic inventory’ now is because of indications that the mining equipment market will likely turn around soon.

Aftermarket Parts Regaining Strength

In order to keep short term operating costs low, mining companies have been working their newer machines for longer durations. This is because older machines demand higher upkeep costs through frequent part replacements and repairs. But now, mining companies have had to undertake aftermarket machine part purchases in order to prevent their machines from downtime. This has led to a turnaround in the mining equipment aftermarket. Caterpillar believes that “the aftermarket piece has stabilized and probably turned the corner and probably has some room to strengthen.” [1]

Resource Industries Retail Sales Decline Has Been Moderating

According to Caterpillar’s retail statistics for the 3-month rolling period ended October, global Resource Industries sales have declined throughout the year. However, it is important to note that the sales decline has been moderating.

Caterpillar Retail Statistics 2014

Since its peak in April at 49%, the decline in retail sales of Caterpillar’s Resource Industries products has slowed down to 20% in October. [2] It is possible that mining equipment sales have bottomed out or are likely to bottom out soon, both situations presenting an encouraging future outlook.

However, it is important for Caterpillar to have timed its strategic inventory buildup accurately. If Caterpillar has moved too early, it will likely be sitting on idle inventory while having incurred manufacturing costs, which may impact margins. However, the past few quarters have proved Caterpillar’s ability to manage its profitability despite flattish or even declining sales. For example, the company’s earnings increased 8% year-on-year in the third quarter, despite sluggish revenues. [3] Also encouraging is Caterpillar’s revision of its earnings per share guidance to $6.00 for 2014, up from $5.75.

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Notes:
  1. Caterpillar’s (CAT) Management Presents at Credit Suisse 2014 Global Industrial Conference (Transcript), December 2, 2014, www.seekingalpha.com [] []
  2. Caterpillar Retail Statistics, www.caterpillar.com []
  3. Caterpillar Inc 3Q 2014 Earnings Release, October 23, 2014, www.caterpillar.com []