Caterpillar's Cost-Cutting Binge Begins

Heavy equipment maker Caterpillar (NYSE: CAT  ) may be one of the more visible victims of the global slowdown in mining, announcing yet another round of layoffs after it had to cut its outlook again for the year following a gloomy earnings report last week, but investors can't look at it in isolation as the malaise weakening the industry is widespread.

Second-seeded Japanese equipment manufacturer Komatsu followed its rival with a depressing earnings announcement of its own the other day, saying it had to reduce its profit forecast by 30% as demand has simply dried up. Even engine maker Cummins (NYSE: CMI  ) was forced to cut its guidance yesterday after reporting lower-than-expected quarterly profits and reducing its full-year outlook as weak sales in most of the industries it serves sapped its strength. It cited the mining sector as one of the most "significant drivers" for the lower levels it reported.

We know that miners from BHP Billiton to Rio Tinto (NYSE: RIO  ) are working double-time to unload non-core assets, but as the latter has found out, the glut of projects on the market is depressing bid prices for them. 

According to a recent Citigroup global mining survey, more than three quarters of respondents say they're cutting their capital expenditure budgets by an average of 14% over the next 12 months with some projects being pushed out two and three years. One ominous data point says the equipment companies shouldn't expect to make up on lost volume with higher prices; there's going to be significant pushback on pricing for drilling equipment, tractors, dozers, and mining trucks, though crushing equipment, pyro processing, and pumps might feel it less so.

That mind-set has put Caterpillar on a "cost lockdown binge," as Cat's CEO said on the earnings conference call, and the hammer is falling first on its mining machinery plant in Kilgore, Texas, where 100 workers will be let go. The plant makes dippers and ballast boxes used in giant electric-powered mining shovels.

The only silver lining to the storm clouds hanging over the industry is China recently reported better-than-expected manufacturing data as the Markit/HSBC Purchasing Managers Index for the country hit a seven-month high. The renewed demand couldn't have come at a better time for the mining industry, which has become dependent upon China's seemingly insatiable appetite for raw materials, but there's no guarantee it will be ramping up its buying habits once again. 

While Caterpillar has initiated temporary factory shutdowns, rolling layoffs, reductions in its flexible workforce, and cuts to discretionary and program costs, it's prudent for investors to ask if this "binging" is enough or will it continue to play economic catch-up? Of course, Wall Street analysts didn't see it coming either, and Cat continues to see signs of hope, but admits things remain dicey. Mine production levels remain elevated, so although that doesn't sound much different than its outlook in previous quarters, now it's occurring from a lower base.

What's benefited Caterpillar has been its ability to generate strong cash flows, particularly in machinery and power systems, despite the hits its resources operations have taken, allowing its balance sheet to improve and some $2 billion worth of stock to be bought back.

Mining doesn't present many opportunities right now, but so long as it continues to align its business with the realities it's facing, should things change it ought to be ready to run ahead.

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Related Tickers

9/30/2016 4:01 PM
CAT $88.77 Up +1.30 +1.49%
Caterpillar CAPS Rating: ***
CMI $128.15 Up +3.89 +3.13%
Cummins CAPS Rating: *****
RIO $33.40 Down -0.30 -0.89%
Rio Tinto CAPS Rating: ***