Mining And Construction Weakness To Temper Caterpillar’s Revenues

Caterpillar (NYSE:CAT) will announce its fourth quarter and annual earnings on Tuesday, January 27. The company is coming off a good third quarter, in which its earnings rose by 8% year-on-year despite sluggish revenues driven by growth in its Energy & Transportation segment, which offset the decline in the Construction and Resource Industries segments. ^[1] The maker of mining and construction equipment was able to grow its profits even as its top line remained flattish, as gains from the company’s cost cutbacks and its locomotives and oil & gas equipment growth outweighed the impact from mining and construction weakness.

For the fourth quarter, we expect to see a decline in Caterpillar’s revenue driven by continued weakness in the Resource Industries segment, as well as poor Construction Industries sales, partially offset by growth in its Energy and Transportation segment. Similar to the past few quarters, we expect to see the company’s profits grow on cost cutbacks and benefits from the decline in oil prices.

Citing continued improvement in cost control and operational execution, CAT raised its earnings per share guidance to $6.00 per share, from $5.75. It also narrowed its annual revenue guidance from $54-56 billion to $55 billion, a decline from 2013 revenues.

See our complete analysis of CAT here

Revenue To Be Pressured Due To Global Mining Weakness

Caterpillar has been struggling due to weak demand for machinery and equipment in the global mining sector since the fourth quarter of 2012. Caterpillar ‘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 Caterpillar’s Resource Industries’ revenue for 2013. ^[2] The after effects 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. Caterpillar’s Resource Industries’ revenue continued to suffer due to this trend throughout 2014.

We anticipate this weakness from the global mining sector to have persisted through the fourth quarter of 2014. Retail statistics released by Caterpillar for the three month rolling period ended November 2014 shows that mining equipment sales remained weak. For the better part of the year, the decline in Resource Industries retail sales was moderating. However, the trend broke in November, with retail sales declining 23%, compared to a 20% decline in the three months ended October. ^[3] This will likely impede the moderation in the decline of Caterpillar’s Resource Industries revenue. After falling 37% last year, the company’s mining segment sales decline moderated to 33% year-over-year in the first quarter, 29% in the second quarter and 19% in the third quarter. ^[4]

Keeping An Eye On Mining Aftermarket Parts

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.” ^[5] We believe that the turnaround in mining equipment aftermarket bodes well for Caterpillar since it indicates that the mining equipment weakness may turn around soon.

Declines In Construction Equipment Sales To Present Headwinds

According to Caterpillar’s latest retail sales statistics, its Construction Industries retail sales have continued to fall, with the declines becoming heavier through the year. Retail sales declined 6% in the three months ended November, compared to 5% in the three months ended October and 3% in the three months ended September. ^[3] The weak Brazilian economy and tough year-on-year comparison with Latin American markets seems to have taken a toll on CAT’s Construction Industries segment. This should further impact Caterpillar’s fourth quarter top line.

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1. Caterpillar Inc 3Q 2014 Earnings Release, October 23, 2014, www.caterpillar.com [↩]
2. CAT’s 2013 Q4 earnings form 8-K, January 28 2014, www.caterpillar.com [↩]
3. Caterpillar Retail Statistics, www.caterpillar.com [↩] [↩]
4. CAT’s 2014 Q2 10-Q SEC Filing, April 2014, www.sec.gov [↩]
5. Caterpillar’s (CAT) Management Presents at Credit Suisse 2014 Global Industrial Conference (Transcript), December 2, 2014, www.seekingalpha.com [↩]