Caterpillar’s Solid Balance Sheet And Cash Flow Support Its Outlook Despite Industry Weakness

by Trefis Team
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    Quick Take
  • Low capital spending from mining companies and inventory reduction by dealers is weighing on Caterpillar.
  • However, the company’s strong balance sheet and cash flow will enable it to weather this current period of weakness in the global mining sector.
  • Caterpillar’s efforts to cut its costs as well as the relatively better performance of its other businesses, construction and power, will also help it offset the negative impact from mining weakness.

Caterpillar (NYSE:CAT) generates around a third of its business from the sale of mining machinery and equipment including mining trucks, loaders, bulldozers and underground roof support equipment. This significant exposure to the mining sector is weighing on the company’s results as capital spending from mining companies has declined in the recent months due to weak demand for many metals and commodities. An increased focus of mining companies on cost control and the return of cash to shareholders after incurring several write-offs has also contributed to the decline in capital spending from the sector. Additionally, the soft demand from mining companies is forcing Caterpillar dealers to slash their machine inventories which is further impacting the company’s sales.

The mining sector weakness impacted Caterpillar’s previous quarter results in which its sales and profits dipped by 16% and 43% annually, respectively. [1] The company expects this weakness to last through 2013, and surveys which the company cited in its second quarter earnings filing suggested that the global mining expenditure could remain under pressure in 2014 as well. However, we are of the view that Caterpillar despite its high dependence on the mining sector will be able to weather this weak period on the strength of its balance sheet, its focus on cost reductions and a relatively better performance of its other businesses.

We currently have a stock price estimate of $86.50 for Caterpillar, marginally ahead of its current market price.

See our complete analysis of Caterpillar here

A Strong Balance Sheet

At the end of the second quarter, Caterpillar’s machinery and power systems segment – which basically refers to its construction, mining and power businesses – had a debt-to-capital ratio of around 35%, well below the upper limit – 45% – of the company’s targeted range. [2] Cash flow from operations also remained strong. This allowed Caterpillar to raise its quarterly dividend by 15% in June as well as repurchase stock. The company repurchased shares worth $1 billion in the second quarter and anticipates repurchasing shares worth another $1 billion in the current quarter. Thereafter, it will still be left with a $2.7 billion in its share repurchase authorization. [2] These active share repurchases soothe investor concerns arising from the current mining sector weakness. However, more importantly these share repurchases indicate that the company has already allocated sufficient capital to fund its growth, and fulfilled its pension and other obligations, as share repurchases as a priority follow these other heads in the company’s capital deployment strategy.

Cost Focus And Construction/Power Businesses Doing Better

Additionally, to counter the decline in its sales Caterpillar is cutting costs through temporary factory shutdowns, rolling layoffs and significant reductions to its flexible workforce. At the same time, the remaining two-thirds of the company’s business – construction and power – is doing better than mining. In construction, though the company’s results were lower on a year-over-year basis in the previous quarter, they improved sequentially with the uptrend anticipated to continue in the current quarter. At power systems as well, the results were stable in the first half of the year and they are likely to maintain this performance in the second half.

Beyond this near-term mining weakness, we believe Caterpillar’s mining business will return to growth, as the global demand for energy and infrastructure, driven by rising urbanization and income levels in the emerging countries will drive demand for mining machinery and equipment.

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  1. Caterpillar’s Q2 2013 earnings form 8-K, July 24 2013, []
  2. Caterpillar’s second quarter 10-Q, August 2 2013, [] []
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