Caterpillar’s Mining Industry Sales Could Witness Growth Amid OPEC Deal Optimism

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The current downturn in commodity prices, economic slowdown of China and global economic uncertainties have resulted in a momentous decline in the last two years and is likely to continue in the short term as economic uncertainties across the globe and lower commodity prices are not allowing the dealers to increase their inventories. However, we expect this situation to start improving after next few quarters due to the increased construction of railroads in hilly areas, increasing demand for coal and technologically advanced mining equipment. Caterpillar (NYSE: CAT) is one of the major producers of mining equipment and its sales have witnessed a heavy decline in the last 2 years due to decline in global mining activities. OPEC countries have agreed to cut their oil production first time after 8 years which already caused crude oil prices to reach close to $50 per barrel. We believe that because of Caterpillar’s increasing presence in the developing countries and the expected improvement in crude oil prices is expected to put a halt to company’s declining revenues in the next few quarters.

 

Why mining equipment market is declining?

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World mining equipment industry includes sales of mineral processing, surface mining and underground mining equipment for the purpose of metal, mineral and coal mining. This market was estimated to be about $73 billion in 2015 despite the slight decline in the last couple of years due to lower commodity prices and reduced mining activity which affected the demand for mining equipment. The mining equipment market grew by more than 10% CAGR between 2010 to 2013 owing to global economic recovery and renewed demand for mining equipment.

Asia Pacific accounted for close to $50 billion or more than 60% of revenues from this sector in 2015 and China is one of the primary consumer of mining equipment. The recent slowdown of the Chinese economy and the downturn in commodity prices due to the oversupply of crude oil from OPEC countries have led to decreased mining activity in the country. We believe that China will continue to be the primary market for mining equipment in near term but the market will grow only when crude oil prices start recovering leading to improved commodity prices.

Short term challenges in the mining industry persist but there is a silver lining

Mining equipment industry continued its decline in 2016 and its effect was evident from about 16% year to date decline in Caterpillar’s resource industry sales till Q3’16. We expect the weakness to continue for the next few quarters as commodity prices are still at a lower level compared to a year ago and the Chinese economy is yet to regain its earlier growth rate. We expect about 6% CAGR for the industry starting 2018  which will be driven by rising construction of roads and railways in hilly areas and increasing demand for coal and technologically advanced mining equipment.

Although China’s GDP growth is not expected to regain its 2013 levels in short term owing to slower private investment and weak external demand, mining activity is likely to grow after next few quarters as crude oil prices are expected to shoot as OPEC countries have finalized the deal to cap their oil production. This deal is likely to result in improved commodity prices globally and hence increase in mining activity. We also expect the mining companies to replace their fleet of old equipment once the commodity prices improve as current used equipment prices are lower due to global economic uncertainty.

Caterpillar likely to benefit from its presence in emerging economies

Approximately 25% of Caterpillar’s resource industry revenues came from Asia Pacific in 2015 but due to the presence of developing economies such as India and China, which are growing at a very high rate compared to other developed economies due to their development activities and increased energy demand, Caterpillar has significant growth potential in this region. Caterpillar’s global mining equipment market share fell from 17.6% in 2013 to about 11% in 2015 due to suppressed purchase activity from Caterpillar dealers in an attempt to lower their inventories in line with the weak global demand for mining equipment and machinery.

We currently forecast Caterpillar’s global mining equipment market share to grow to 13.3% by the end of our forecast period due to Caterpillar’s increasing presence in fast-growing emerging economies such as India. However, if Caterpillar’s market share increases to 20% by the end of our forecast due to the expected recovery in crude oil prices which will enable Caterpillar dealers to increase their inventories, our price estimate for Caterpillar has about 10% upside potential.

Notes:

1) The purpose of these analyses is to help readers focus on a few important things. We hope such lean communication sparks thinking, and encourages readers to comment and ask questions on the comment section, or email content@trefis.com

2) Figures mentioned are approximate values to help our readers remember the key concepts more intuitively. For precise figures, please refer to our complete analysis of Caterpillar

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