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Despite an Awful 2013, Upside Remains for Caterpillar

Caterpillar's product show floor. Photo credit: Caterpillar.

Caterpillar (NYSE: CAT  ) continues to trudge through a dreadful year as sales continue to decline amid weak global demand for mining equipment and large machinery. You can break Caterpillar's business down into three main segments: construction industries, power systems, and resource industries. The latter segment focuses on making equipment for mining industries and has been the main reason for the company's decline. The good news is that there may be a reason for long-term investors to stick around.

Caterpillar's third-quarter earnings took a 44% nosedive and aren't looking to improve over the near term. Looking at sales in three month chunks, at the end of the third quarter, its sales of machinery and power systems had declined 9% and 2%, respectively. For the three-month period ended October 31, Caterpillar posted a 12% decline in machinery sales and a 9% decline in power systems -- an uninspiring result. 

Photo credit: Caterpillar.

"This year has proven to be difficult, with expected sales and revenues nearly $11 billion lower than last year. That is a 17% decline from 2012, with about 75% of the drop from Resource Industries, which is principally mining. We expect Resource Industries to be down close to 40% for the full year and Power Systems' and Construction Industries' sales to each be down about 5%," said Caterpillar Chairman and CEO Doug Oberhelman in the third-quarter presentation.

Caterpillar's sales in its Asia-Pacific region were hit the hardest, with a 26% decline in machinery sales in the three months ended October 31. Europe also witnessed a 14% slide while Africa and the Middle East posted a 9% drop.

While Caterpillar expects there to be global growth in 2014, it stopped short of expecting any improvement in earnings. Until there's substantial growth, Caterpillar will be forced to continue its cost-cutting efforts.

Caterpillar will likely continue to slash jobs until demand returns. It recently announced it will be closing its Pulaski, Va., mining equipment facility and will move the operation to its Pennsylvania facility -- a loss of 240 jobs. That's in addition to the more than 13,000 jobs already cut by Caterpillar globally. 

Also, with Caterpillar losing significant sales in the Asia-Pacific region, it will have its work cut out for it to regain sales in China, where it trails Komatsu -- a rare second place for Caterpillar. Caterpillar is heavily exposed to the mining end market, which has faced shrinking demand as China's economic activity continues to move at a historically slow pace.

While it's definitely ugly for Caterpillar investors right now, and the near term looks just as dark, there is upside remaining for long-term investors.

The upside
Firstly, Caterpillar has a strong dealer network with a great reputation for high quality, which minimizes customer downtime -- a critical factor for customers. Also, as the world's largest construction and mining equipment manufacturer, its economies of scale is second to none. As the global economic recovery slowly continues, it should provide stronger demand equipment demand for Caterpillar in the medium to long term. This is especially true if China resumes a faster growth pace than we've seen over the past year and Europe continues to come back from its rock-bottom economic situation.

Secondly, while the near term does indeed look frightful, Caterpillar has consistently returned value to shareholders, which could give investors enough reason to jump in for the long haul. Consider that even during this rough patch, the company has increased its dividend by 15% in the second quarter, and repurchased $2 billion of common stock this year. This appears to be sustainable as Caterpillar expects this year's cash flow to be the second best in its history. If you believe the slow-but-sure global economic recovery will continue, Caterpillar is an intriguing long-term investment -- it at least belongs on your watchlist through 2014 while the situation continues to unfold. 

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5/27/2016 4:00 PM
CAT $71.96 Down -0.12 -0.17%
Caterpillar, Inc. CAPS Rating: ***