Caterpillar’s 2013 Doesn’t Look Great
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Global equipment manufacturer Caterpillar (NYSE: CAT) posted weak first quarter results on the back of a decline in global mining capital expenditures. Revenue dropped 17% year-over-year to $13.2 billion, which was slightly below consensus expectations. Earnings tumbled 45% year-over-year to $1.31 per share, which was also worse than consensus estimates.
The decline during the first quarter wasn’t much of a surprised as the outlook for mining capital expenditures declined precipitously as commodity prices tumbled. In fact, Cat’s revised outlook accounts of a 50% year-over-year decline in sales of the firm’s traditional mining equipment and a 15% decline in sales of the equipment sold by Bucyrus.
Sales fell 23% in the resource segment for the quarter, and with most of the global mining giants like Rio Tinto (NYSE: RIO), BHP (NYSE: BHP), and Anglo American dealing with new supply coming on-line, prices remain weak. Naturally, we at Valuentum think this news looks bearish for competitor Joy Global (NYSE: JOY) which relies mostly on mining activity to generate revenue. Although we think Joy Global looks overvalued, we believe the company could be an acquisition target, so there are some real risks to a short position. On the other hand, Cat’s bearish outlook for mining sales could be bullish for the diversified miners because the firms may slash capital expenditures at a more aggressive rate than anticipated. This could result in a positive impact to free cash flow.
Supply remains the largest threat to industry profitability and cash flow because significant mining supply is coming on-line at Rio, Vale, and Anglo American’s Minas Rio project. In effect, large amounts of iron ore supply could come to market at the same time demand growth moderates to reflect less robust demand from China. While certainly a valid concern, Valuentum believes these fears may be slightly overblown and underestimate other emerging markets’ role in consumption. Further, Chinese real estate steel demand growth may decelerate, but the country will still add several million cars to the road over the next decade.
Caterpillar’s construction business was also weak, as sales fell 17% year-over-year to $4.2 billion. Sales in North America declined 14% to $1.5 billion, which was stronger than the 17% decline in Asia-Pacific and the 23% decline in EAME. We think continued strength in the US housing market could provide a positive catalyst, but it is important to recall that the company boosted dealer inventories last year, so sales growth might not translate immediately. Nevertheless, we do not feel as bullish about a recovery in Chinese construction; another key lever for Cat’s growth.
With regards to China, management provided what we believe was fairly bearish commentary, saying:
“I am pleased to report this morning that we along with our dealers have made quite significant progress in lower inventory. Dealer machine inventories declined throughout 2012 and are currently at reasonable levels relatively to sales.
In terms of our inventory, that’s Caterpillar finished inventory in China, as expected it declined during the first quarter. While inventory reduction is expected to continue into the second quarter, we do expect to begin increasing production in China during Q2.”
We tend to agree with this outlook, and in our view, the read-through seems to suggest current demand remains sluggish. If China remains weak, the impact on Caterpillar could be disastrous. Not only does China account for a significant amount of revenue directly, but the country also accounts for a large portion of resource consumption growth. When China doesn’t buy resources, mining firms don’t need to purchase new mining equipment, which clearly would have a negative impact on Cat.
Power systems proved to be most resilient segment in the first quarter, falling 12% year-over-year. Order trends were pretty mixed. Fracing and drilling were weak, but compression, the other component of oil & gas, saw orders increase. Caterpillar also noted that rail and solar performed well.
Looking ahead, the firm reduced its guidance to revenue of $57 billion to $61 billion generating earnings per share of $7. This guidance was well below consensus expectations, but it is not surprising given the current outlook for the global mining industry. We do not see much upside to the forecast in 2013 given the sluggish growth of the global economy.
Ultimately, Caterpillar’s quarter wasn’t good, nor was its guidance at all positive. As a result, we continue to believe shares look fairly valued. Cat’s business is highly cyclical, and therefore, we are very cautious and demand a significant margin of safety before getting comfortable adding shares to the portfolio of Valuentum's Best Ideas Newsletter.
RJ Towner has no position in any stocks mentioned. Valuentum holds shares of Rio Tinto in its Best Ideas Newsletter portfolio. The Motley Fool has no position in any of the stocks mentioned. 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!