Mining Activity Continues to Plague these Companies

There's demand for basic materials but supply is still too high, that's why miners continue to pull back—bad news for this pair of equipment makers.

Feb 4, 2014 at 11:00AM

Last year was a bad one for mining companies dealing with falling pricing in the face of too much supply. It was also a bad year for mining equipment makers Caterpillar (NYSE:CAT) and Joy Global (NYSE:JOY). It doesn't look like much is going to change for this pair in 2014.

Picks and shovels
Caterpillar and Joy Global are basically the pick and shovel makers of the mining industry. That was a great business to be in when miners were expanding aggressively to meet soaring Chinese demand. However, Chinese growth has begun to slow and demand isn't as robust as it was before. Although there is still plenty of demand, the mining industry went overboard on expansion and now there's a supply glut. Commodity prices, in turn, have fallen.

That's led to a pullback in capital spending and caused a nearly 50% drop in mining equipment sales at Caterpillar in the fourth quarter. Luckily for Cat, its other business lines actually saw sales increases, with power systems up 5% and construction up 20%. Joy Global, which primarily sells mining equipment, saw a sales drop of around 25%. Ultimately, the mining weakness is pretty awful news for both companies.

And the future looks equally bleak. Caterpillar's mining sales have been roughly flat for the last couple of quarters at around $3 billion. That's the quarterly level it expects to see, on average, throughout 2014. Joy, meanwhile, took additional restructuring charges in the fourth quarter, "To further reduce and align our cost structure with the expected lower sales volume in 2014..." That's meant headcount reductions and facility closures, and the company isn't done yet—it expects "...additional restructuring charges and savings..." this year.

What about the miners?
So Caterpillar and Joy Global are looking at another tough year, but what about their customers? According to Cat "....mine production and commodity consumption have generally been up in 2013, and based on improving economics, we are expecting both to increase again in 2014." That's good news, but that appears to be working off an oversupply situation since it isn't pushing commodity prices higher.

And all sectors aren't created equal here. For example, Edward Doheny, Executive Vice President of Joy Global, notes that, "We know where we put in a lot of our longwall systems around the world. And so we know we have some high productivity, low-cost production coming online in 2014." That comment is specific to metallurgical coal.

That's bad news for miners like Arch Coal (NYSE:ACI) and Alpha Natural Resources (NYSE:ANR). Both companies are big met miners, with steel making coal accounting for nearly half of the business at each company. Walter Energy (NASDAQOTH:WLTGQ) is in an even worse position as it enters 2014 because it focuses almost exclusively on met.

Alpha and Arch could both see support from their U.S. thermal operations, which will help offset continued met weakness. That said, Arch has an enviable position in the low-cost Powder River Basin (PRB), where about 45% of its sales are derived, compared to Alpha, at only 10% or so. That's a big benefit since the U.S. Energy Information Administration believes that "...the remaining stockpiles supported fewer days of burn for subbituminous coal than for bituminous coal, implying greater demand for delivery of PRB coal."

However, profit margins in metallurgical coal are much higher than in thermal coal, so a rebound in met pricing is vital to all three companies' top and bottom lines. All three have been bleeding red ink for a year or more—Alpha's streak is around two years.

Another tough year
Caterpillar and Joy Global are telegraphing another tough year in 2014 for their mining equipment businesses. And Joy is hinting at another difficult one for met miners like Arch, Alpha, and Walter. That said, as Caterpillar notes, "Increasing mine production and end users [miners] buying below replacement levels will eventually lead to higher purchases of equipment." However, this might not happen until after commodity prices start to head higher.  

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Reuben Brewer has no position in any stocks mentioned. 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.

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