Caterpillar Revised To $85 On Oil Prices, Continued Mining Weakness

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Caterpillar

Caterpillar’s (NYSE:CAT) revenue been suffering from a decline in its Resource Industries segment due to weak demand for machinery and equipment in the global mining sector since the end of 2012. To add to its woes, crude oil prices have declined to a level where Caterpillar’s (CAT’s) Energy and Transportation segment will feel the pinch. This is a cause for concern for the company, since Energy and Transportation was the segment that it was relying on for growth in the short term, as the company’s Construction Industries segment also took a dive in the third quarter of 2014. The strong U.S. dollar is also likely to have an impact on the company’s revenues. Given these headwinds, we have revised our price estimate for Caterpillar to $85.

See our complete analysis of CAT here

Low Crude Oil Prices To Impact Sales

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Things aren’t looking good for crude oil prices in the near future. According to the February release of the U.S. Energy Information Administration’s (EIA) Short Term Energy Outlook report, global crude oil inventories are likely to remain high. Global crude oil production is expected to be 93.8 million barrels per day in 2015, while consumption will remain considerably lower at 93.1 million barrels per day. [1]

Apart from growth in production in the U.S., global crude oil supply is also receiving a boost due to the unwillingness of the Organization of the Petroleum Exporting Countries to lower their output, fearing that it will negatively impact their market share.  On the demand side, China, the largest oil importer in the world, is likely to import less in the near term given that its GDP growth is expected to decline from 7.4% in 2014 to 7.0% in 2015. [2]

With a demand-supply mismatch, crude oil prices will likely remain low. The EIA forecasts an average price of $58/bbl for Brent crude oil and $55/bbl for WTI crude oil in 2015. [1] This sparks a concern for Caterpillar, whose sales to the oil and gas industry account for around a third of its Energy and Transportation revenue. According to Caterpillar and its customers, crude oil prices within the range of $80-90 were acceptable for sustained production. However, management mentioned that prices in the low 70s “would bring a chill across the market” and will likely impact Caterpillar’s business. [3] Given that crude oil prices are presently significantly lower than Caterpillar and its customers’ threshold, its Energy and Transportation sales are likely to decline. 

Caterpillar’s Machine Retail Statistics Remain Weak

Huge asset write-offs and declining commodity prices have forced mining companies to reduce their capital spending in terms of purchasing new equipment or spare parts. As a result, the revenue for Caterpillar’s Resource Industries segment, which sells mining equipment, declined 37% and 33% year-on-year in 2013 and 2014, respectively. [4]

Retail statistics released by Caterpillar for the three month rolling period ended January 2015 shows that mining equipment sales remain weak. For the better part of 2014, 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. [5] Retail sales continued to fall in the next two months, declining 22% in December and 27% in January. With most oil and gas exploration and production companies reducing their capital spending budgets for the year, it is likely that mining equipment sales will remain low, leading to continued decline in Caterpillar’s Resource Industries sales in 2015.

Caterpillar’s Construction Industries retail sales also continued to fall, with the declines becoming heavier every month. Retail sales declined 10% in the three months ended January, compared to 9% in the three months ended December and 6% in the three months ended November. The Brazilian economy, tough year-on-year comparison with Latin American markets, and a slowdown in construction activity in China will continue to take a toll on Caterpillar’s Construction Industries segment. Also, the segment is likely to suffer due to its indirect reliance on oil and gas industry. A considerable portion of Construction Industries sales is tied to frac pads, roads to drilling sites or pipelines, which could decline as a result of the weak crude oil prices.

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Notes:
  1. SHORT-TERM ENERGY OUTLOOK – Global Petroleum and Other Liquids, February 10, 2015, www.eia.gov [] []
  2. China plans to set 2015 growth target at ‘around 7 percent’ – sources, January 28, 2015, www.reuters.com []
  3. Caterpillar’s (CAT) CEO Doug Oberhelman on Q3 2014 Results – Earnings Call Transcript, October 23, 2014, www.seekingalpha.com []
  4. Caterpillar’s 2014 10-K SEC Filing, www.sec.gov []
  5. Caterpillar Retail Statistics, www.caterpillar.com []