Forget a Mining Sector Slowdown, Caterpillar Inc Has Another Problem on Its Hands

Watch stocks you care about

The single, easiest way to keep track of all the stocks that matter...

Your own personalized stock watchlist!

It's a 100% FREE Motley Fool service...

Click Here Now

Caterpillar (NYSE: CAT  )  and Joy Global  (NYSE: JOY  ) have a problem: China. No, I'm not talking about the Chinese economy here, I am in fact talking about the quality of mining equipment being manufactured within China, which has drastically improved in recent years.

It used to be the case that mining companies, such as Rio Tinto (NYSE: RIO  ) , would stay away from native mining equipment manufacturers within China as the kit was usually of an inferior quality, although the equipment was cheaper. However, now the Chinese companies are catching up. Indeed, according to comments from Rio Tinto CEO Sam Walsh given in an interview with the Wall Street Journal:

The Chinese manufacturers are really improving in this field and can now be compared to the major US manufacturers... funnily enough [on the rail cars] the quality actually was much higher [compared to the miner's traditional supplier]...Instead of spot welds, for example, on the sheet metal they were actually continuous welds.

Spot welds are usually weaker than a continuous weld. As a result, Walsh revealed that Rio had actually been increasing its purchases of heavy equipment from Chinese and Indian companies. Now I don't want to speculate, but I would say that the Chinese are able to put more effort into the production of their equipment due to lower labor and construction costs, while Western companies are skimping on quality to save costs.

Unfortunately, it would appear that the quality of Chinese mining equipment is only going to improve from here on out while costs continue to fall.

I say this because according to a study entitled China Mining Equipment Industry 2013-2017 published back in June 2013, China's domestic mining and quarrying equipment manufacturing industry is expected to expand by about 22% by 2017, increasing economies of scale. The study also highlights the fact that China's producers will emerge as industry favorites due to their low cost.

All in all, this means that miners like Rio will be able to buy better heavy equipment for a lower cost. In addition, it is likely that as the quality of the equipment continues to improve, maintenance costs will fall. This is really bad news for companies like Joy and Caterpillar, which are already struggling to grapple with rapidly declining resource sector capital spending.

Getting worse
Actually, mining capex is declining faster than originally thought. Specifically, during 2012 JPMorgan analysts predicted that global mining capex would decline 14% from a high of $136 billion during 2012, to $117 million for this year. However, it is estimated that global mining capex will only amount to around $100 billion this year, 15% lower than original estimates.

Unfortunately, Joy and Caterpillar are already suffering from this downturn, and it looks as if things will only get worse for these companies, even before we consider the effect of an increase of Chinese equipment in the market.

Joy's fiscal fourth quarter results reveal how serious this slowdown already is. In particular, the company reported that quarterly earnings per share declined 47% year on year. Additionally, sales collapsed 26% year on year, and bookings for new equipment declined by 20% year on year.

In comparison, Caterpillar reported a slightly better 33% year-on-year decline in earnings for 2013. Caterpillar also, within its 2013 earnings announcement, issued a primary 2014 outlook stating:

We see some signs of improvement in the world economy, which should be positive for sales in our Construction Industries and Power Systems segments. However, despite our expectation that mine production will continue to increase, we expect mining companies to further reduce their capital expenditures in 2014. As a result, we're expecting sales in Resource Industries to decline modestly.

So all in all, with the world's largest mining equipment producer taking such a pessimistic view on the future of the mining industry, it's hard for individual investors to remain positive.

Foolish summary
It's no secret that capex in the mining industry is falling, and this is bound to hurt the industry's largest capital equipment manufacturers, Joy and Caterpillar. Nonetheless, the speed of the decline in capex has surprised many, and further bad news continues to hit the market in the form of improved competition from China. All in all, the outlook for Joy and Caterpillar is bleak, and it could get worse.

A safer bet
As every savvy investor knows, Warren Buffett didn't make billions by betting on half-baked stocks. He isolated his best few ideas, bet big, and rode them to riches, hardly ever selling. You deserve the same. That's why our CEO, legendary investor Tom Gardner, has permitted us to reveal The Motley Fool's 3 Stocks to Own Forever. These picks are free today! Just click here now to uncover the three companies we love. 

Read/Post Comments (2) | Recommend This Article (2)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 18, 2014, at 12:45 PM, jjvors wrote:

    Overly negative, in my opinion, for these reasons:

    1. No mention is made of Caterpillar's construction, power, or finance divisions, which provide 70% of its revenue.

    2. No mention is made of Caterpillar's parts business, which supplies most of its profit. Parts sales are likely to increase due to aging equipment and reduced dealer inventories.

    3. No mention is made of the rest of the world: Americas, Europe, Africa, and non-China asia. These areas are showing growth.

    4. No mention is made of the Keystone pipeline, a big project for Cat pipelayers, Solar turbines, Cat gensets.

    There's more to the story, but that's enough for now.

  • Report this Comment On February 21, 2014, at 12:04 PM, PGM wrote:

    Overly negative for the reasons stated above as well as: The author doesn't want to specualte but he says "Now I don't want to speculate, but I would say that the Chinese are able to put more effort into the production of their equipment due to lower labor and construction costs, while Western companies are skimping on quality to save costs." That is speculation because he cites no evidence at all. Secondly, he cites a report China Mining Equipment Industry 2013-2017 that has lots of projections so that is speculative as well and the source of the report is not mentioned. Also, of note, the article is published as CAT stock keeps rising so I get a reall "short" seller's slant here.

Add your comment.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2842904, ~/Articles/ArticleHandler.aspx, 9/4/2015 11:00:17 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

Rupert Hargreaves

Rupert has been writing for the Motley Fool since December 2012. He primarily covers tobacco and resource companies with a passion for value-oriented investments. .

Today's Market

updated Moments ago Sponsored by:
DOW 16,155.48 -219.28 -1.34%
S&P 500 1,926.13 -25.00 -1.28%
NASD 4,702.05 -31.45 -0.66%

Create My Watchlist

Go to My Watchlist

You don't seem to be following any stocks yet!

Better investing starts with a watchlist. Now you can create a personalized watchlist and get immediate access to the personalized information you need to make successful investing decisions.

Data delayed up to 5 minutes

Related Tickers

9/4/2015 10:44 AM
CAT $73.09 Down -1.36 -1.83%
Caterpillar, Inc. CAPS Rating: ***
JOY $19.70 Up +0.80 +4.23%
Joy Global, Inc. CAPS Rating: ****
RIO $34.08 Down -1.52 -4.26%
Rio Tinto plc (ADR… CAPS Rating: ***