Weak demand for mining machinery and equipment weighed on the third quarter results of Caterpillar (NYSE:CAT). The maker of construction, mining and power equipment saw its sales fall by $3 billion or 18% annually to $13.5 billion in the third quarter, due to a combination of soft end-user demand from mining companies and a reduction in dealer inventories in anticipation of soft demand. 
As CAT sells its products to its dealers who in turn sell them to end-users, which include mining and construction companies, it is open to impact from fluctuations in its dealer inventories. In the third quarter, nearly half of the company’s top line drop came from reduction in its dealer machine inventories, which fell by $800 million during the quarter, as opposed to a rise of $800 million in the year ago period. 
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The remaining top line decline was driven by weak end-user demand, particularly from the mining industry. CAT dealer’s sales volumes to the mining sector fell significantly in the third quarter, as mining companies cut capital expenditures in light of the weak demand for many metals and commodities. This impact from softness in the global mining markets on CAT’s sales volume was enhanced by some issues surrounding mining companies that included an increased focus on cost and capital controls after having incurred several write-offs in the recent past. Some mining companies also underwent recent management changes, which also contributed to the decline in capital spending from the sector.
On its part, CAT responded to this decline in sales volume with cost-cuts, which included headcount reductions, temporary plant shutdowns, lower incentive pay and implementation of austerity measures across the company. On a year-over-year basis, the company slashed its total workforce – full-time and flexible – by over 13,000 employees to around 137,000 employees at the end of the third quarter. However, in spite of such steps, earnings of the company fell by 43% annually to $1.45 per share in the third quarter. 
Order inflows also remained weak throughout the quarter as opposed to a recovery anticipated by CAT. As a result, the company was forced to revise its sales and profit outlook downward for 2013. CAT now expects its 2013 top line to be around $55 billion, down from $56-58 billion guided earlier, and its 2013 earnings to be around $5.50 per share, down from $6.50 per share guided earlier. These revised forecast figures compare to the company’s sales of $66 billion and earnings of $8.48 per share last year. The nearly $11 billion year-over-year drop in CAT’s top line is driven by mining sector weakness with the company forecasting that nearly 75% of this top line drop will come from its mining segment. For full year 2013, CAT expects its mining sales to be down around 40% y-o-y and its construction and power sales to be down around 5% each on a year-over-year basis. 
We currently have a stock price estimate of $86.41 for Caterpillar, marginally above its current market price. We are in the process of incorporating CAT’s third quarter earnings and shall update our analysis shortly.
CAT’s Mining Exposure And Outlook
Manufacture and sale of mining trucks, loaders, bulldozers, underground roof support equipment and other mining machinery constitute around a third of CAT’s total business. The company’s exposure to this sector increased in 2011, following the $8.8 billion acquisition of Bucyrus, at which time the outlook for mining industry was positive. However, at the end of the third quarter, the company foresees the current weakness in the mining sector to persist through the fourth quarter. We figure that with the monetary and fiscal policy direction uncertain in the U.S., a slowdown in Europe and a shift towards a more consumption-led growth in China, mining sector weakness will likely persist for the foreseeable future. Thus, CAT’s results in the fourth quarter and possibly in early 2014 will continue to get impacted from weak mining sector demand.
CAT also said in its earnings release that it expects dealer inventory reductions to continue in the fourth quarter. Thereafter, we figure that further large scale dealer inventory reductions would be unlikely as large scale reductions would have already taken place in 2013.
Construction And Power Segment Results Relatively Better
On the bright side, the remaining two-third of CAT’s business – construction and power – posted relatively better results. Third quarter sales at both these segments declined by 7% annually, compared to the 43% annual decline in sales at the company’s mining segment.  Additionally, CAT’s sales from China continued to rise in the third quarter.
Looking ahead, CAT insisted that it could take deeper measures to lower its cost structures. We figure this will help it counter the impact from the weak macro environment. The company also said that it will continue with its share repurchases. At the end of the third quarter, CAT had $1.7 billion left in its share buyback authorization. The company repurchased $2 billion of its shares in the past two quarters, in an attempt to maintain its shareholder returns.  We figure that continued share repurchases coupled with CAT’s healthy dividend payouts, will help ease investor concerns arising from the current uncertain mining industry environment.Notes: