Weak Mining Demand Will Continue To Dig In To Caterpillar’s Results

Caterpillar (NYSE:CAT) will announce its fourth quarter earnings Monday, January 27. The maker of mining, construction and power equipment will likely post significantly lower revenues due to weak demand from the global mining sector, which constitutes around a third of its total business. The company’s profits, however, will likely not fall on a year-on-year basis as they will be measured against very weak numbers in the fourth quarter of 2012. Overall, Caterpillar’s (CAT) fourth quarter results will show the impact from a weak mining sector demand and its own dealer inventory reductions.

The company faced a similar tough macro environment in the first nine months of 2013, when its revenues fell by 17% or $8.5 billion annually and its earnings slumped by 44% annually. The largest portion of this decline came from its mining segment where sales fell by 33% or $5.4 billion annually due to lower demand for machines and equipment from mining companies, which focused on cost and capital control after incurring several asset write-offs in the recent past. ^[1] Seeing weak end-user demand from mining companies, CAT dealers also reduced their machine inventories, further impacting Caterpillar’s sales. As Caterpillar (CAT) sells its machines and equipment to its dealers who in turn sell them to end users like mining and construction companies, it gets impacted from fluctuations in its dealer inventories. In the third quarter of 2013 alone, CAT dealers slashed their machine inventories by around $800 million, which weighed directly on CAT’s sales. ^[2]

For full year 2013, due to mining weakness, CAT forecasts its sales to be around $55 billion, down from $65.8 billion in 2012 and its earnings to be around $5.50 per share, down from $8.48 per share in 2012. ^{[2] [3]} We currently have a stock price estimate of $88.43 for CAT, marginally below its current market price.

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Cost Cutbacks Partially Offset The Decline In Top Line

On its part, to deal with this significant fall in its revenues, CAT unleashed massive cost cuts. In the first nine months of 2013, the company lowered its operating costs by over $5 billion. ^[1] CAT reduced its workforce – full-time and flexible – by over 13,000 employees in one year alone to 137,000 employees at the end of the third quarter. ^[2] The company also reduced its research and development expenses by 15% annually, and its selling, general and administrative costs significantly through across the board austerity measures. The company also shut down many plants temporarily to further clamp down on costs. These measures continued through the fourth quarter and we expect them to partially offset the negative impact on CAT’s profits from its lower top line.

CAT’s Exposure To Mining Increased After The Bucyrus Acquisition

Caterpillar’s exposure to the global mining sector increased in 2011 after its $8.8 billion acquisition of Bucyrus, which is a leading manufacturer of mining equipment and machinery. At that time, the outlook for the global mining sector was bright. However, as many mining companies invested too heavily and too fast to increase their production levels, prices of many commodities including coal and iron ore were impacted. At the same time, a few major mining companies incurred massive write-offs in some of their projects. In all, the bright outlook of 2011 turned bleak by late 2012 and remained as such through 2013. Looking ahead, we anticipate this weak macro environment to persist at least through early 2014, where after it could improve, driven by growing demand for energy and infrastructure from the emerging countries.

CAT’s Construction & Power Segment Results Will Likely Be Better

Separately, Caterpillar’s other businesses – construction and power systems – will likely hold better than its mining business in the fourth quarter. Results from these segments haven’t declined as much as those from its mining segment. Additionally, we figure recovering housing market in the U.S. and bottoming out construction spending from Europe will likely help grow results at CAT’s construction segment in the fourth quarter.

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1. Caterpillar’s 2013 Q3 10-Q, November 1 2013, www.caterpillar.com [↩] [↩]
2. CAT’s 2013 Q3 earnings form 8-K, October 23, 2013, www.caterpillar.com [↩] [↩] [↩]
3. CAT’s 2012 10-K, February 19 2013, www.caterpillar.com [↩]