Does Declining Demand Indicate Falling Profits for Caterpillar in Prospective Periods?

Muhammad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Caterpillar (NYSE: CAT) is one of the largest manufacturers of construction and mining equipment, natural gas and diesel engines, diesel-electric locomotives, and industrial gas turbines. The major segment of the company is machinery and power systems, and this segment is expected to witness a fall in demand as the mining companies attempt to lower their capital expenditures. A major proportion of Caterpillar’s revenue is formed by sales of equipment to mining companies, and if these companies limit their acquisitions of such equipment, it will have a negative influence on Caterpillar’s revenue.

Declining Market Performance

According to analysts, the mining sector as a whole could observe some regulatory restrictions after the re-election of President Barack Obama. Although the stock of the company is performing better than its 52 week low (9.58% above it), it is significantly lower than its 52 high (26.37% below it). All these factors reflect badly on Caterpillar’s market performance, as the share price of the company is following a downward trend and major analysts, such as JP Morgan, have lowered the rating of the company. Caterpillar’s share price target was lowered to $90 from $109. This is a significant reiteration and the impacts of this revision are expected to be witnessed in the market performance of Caterpillar’s shares in the foreseeable future.

The decline in demand from mining companies is not confined to Caterpillar; its effects can be observed throughout the industry. Major competitors of the company, such as CNH Global NV (NYSE: CNH) and Freeport-McMoRan Copper & Gold (NYSE: FCX), seem to be following the same trend in market performance as Caterpillar. In the third quarter, Freeport-McMoRan Copper & Gold reported net income of $824 million that was down to $1.10 per share in 3Q of 2011, whereas the analysts are expecting to have a profit of $1.16 per share in CNH Global NV 3Q earnings.

Caterpillar’s Financial Highlights

Although there have been some weaknesses contributing to the company’s declining market performance, Caterpillar still retains strength in multiple areas. Caterpillar has maintained its growth in revenue and its return on equity is also impressive. The company has also disclosed growth in its net income.

Caterpillar has shown plausible performance with regard to revenue as its revenue growth was slightly higher than the industry average of 0.3%. In comparison with the same quarter of the last financial period, the revenue grew by 4.6%. The earnings per share increased significantly by 48.5% in comparison with the same quarter last year. This rise in earnings per share of the company can be directly attributed to its revenue growth.

The company has maintained the trend of growth in EPS for the past two years and according to analysts, this trend is expected to continue in the future periods. The net income increased by 48.9% as compared to the same quarter of the last financial period, rising to $1,669 million. Caterpillar has also shown an increase in its return on equity when compared to the same quarter last year. The gross profit margin of the company is still lower than expected at 33.6%; however, this low gross profit did not create any hurdles in the way of the company’s net profit margin, which stood at 10.3%.

Caterpillar Shuts Down Its Owatonna Plant

Despite fair financial results, the prospects for the company look grim as the scope of the operations of the company succumbs to the declining developmental activity. Recently, the company shut down its plant in Owatonna, causing the elimination of 100 jobs. The shutdown of this plant and the declining demand for mining equipment do not present a bright picture for the company’s prospective financial performance.

Rising Demand for Generators Post Hurricane Sandy

While the demand for equipment related to the mining industry declined, the power disruption caused by Hurricane Sandy pushed the demand for generators to a higher level. Weeks after Sandy caused disruption in power in 11 states a large number of customers are still without power. This situation created an opportunity for Caterpillar and Generac Holdings (NYSE: GNRC) to increase their generator sales. The companies even faced some problems with supply chain as the demand increased suddenly.

In my opinion, investors should hold the shares in the company as selling them at this point may not be beneficial. There are multiple factors that indicate that Caterpillar may continue its trend of rising revenue and EPS; therefore the market performance of the company may be expected to be better in the long term.

muhammadbazil owns shares of Caterpillar. The Motley Fool owns shares of Freeport-McMoRan Copper & Gold. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

blog comments powered by Disqus