Is Caterpillar Off Your List? Think Again

With innumerable bumps in the road ahead of it, can Cat make it through and deliver in the long run?

Apr 1, 2014 at 1:03PM

Short-term thinking can magnify small issues to make them look gigantic. Everything seems to be going wrong for mining and construction machinery giant Caterpillar (NYSE:CAT) at the moment -- trailing mining sector, weakening China, tax evasion allegations, and what not. But does this mean the company's no good? Let's dig out some evidence that vouches for Cat.

Cat
740B Articulated Trucks. Source: Caterpillar

A brief look into what's troubling Cat
For the past 18 months, the slump in the mining sector has been quite a pain. Low commodity prices have led to production cuts and, in turn, lowered demand for equipment. Caterpillar missed analysts' forecasts for three consecutive quarters in 2013, with full year sales taking a 16% year over year hit to $55.7 billion. Mining equipment sales of the behemoth plunged an astounding 50%. Joy Global (NYSE:JOY), which is exclusively into mining equipment, also saw sales drop 25% in the year.

Both companies don't see much changing in 2014. According to a Bloomberg report, mining companies will continue to cut capital expenditures till the end of 2015 as they struggle with cash flow generation in the face of weak metal prices. The consensus estimates say that the top 10 mining companies reduced capital spending by 17% in 2013, and could cut approximately 10% or more in 2014 and 2015. These companies contribute 80% toward the entire industry's capital spending. Though Cat's 2014 revenue forecast topped expectations, sales will remain flat at 2013 levels. Joy's outlook is in the same vein.

The slowing economic growth in China has been another major concern. Data released in March shows that manufacturing growth has hit an eight-month low, jeopardizing China's 7.5% growth goal. Cat has big exposure to the country, so bad news for China spells bad news for the company. To add salt to its wounds, after losing a big contract to Siemens AG and Cummins, Caterpillar is now facing a Senate investigation into alleged tax evasions of more than $2 billion!

It's easy to overlook Cat's strong points in the backdrop of such daunting headwinds. But here's why it would be wrong to ignore it entirely.

Construction is looking up
Cat is the global leader in construction machinery production, and saw a 44% profit hike in the fourth quarter owing to a 20% increase in construction segment sales. Construction machinery forms roughly one-third of Cat's annual sales.

In the U.S., 2014 forecasts are positive for both residential and non-residential construction. Home building has suffered recently due to inclement weather but things can change now that spring is upon us. NAHB chief economist David Crowe recently said that competitive mortgage rates, affordable home prices, and an improving economy can strengthen housing activity through the rest of the year. What's more, non-residential construction in the U.S. could see up to 5.8% growth in 2014, according to American Institute of Architects, driven by 10.3% rise in commercial construction. Caterpillar also believes improved state and local government budgets will push up infrastructure spending.

Restructuring and dealer push
Throughout 2013, Caterpillar tried to cut costs through restructuring. The plan will continue this year and start yielding benefits soon. The company has shut some of its factories, downsized some others, and laid off more than 10,000 employees in the past year. To make its European operations more competitive, Cat is going to undertake major restructuring at its Gosselies factory in Belgium, including laying off employees, reshaping the supply base, and focusing more on machine assembly, test, and paint, and less on component and fabrication operations.

While the going is tough, Caterpillar is shoring its strengths, so that it can make the most of the good times when they arrive. The company's "single biggest competitive advantage", according to Stuart Levenick, group president of customer and dealer support, is its dealer organization. The company's trying to improve the performance of its network of 178 independent dealers worldwide to boost the top line. Caterpillar feels that dealers can capture additional business in the range of $9 billion-$18 billion. It's given them until the end of 2014 to draw up a three-year plan for increasing sales. The initiative could bolster sales irrespective of the macroeconomic conditions.

Keep the faith
Caterpillar, in its 2014 outlook, says that the world economy is rebounding and will grow around 3% as economic conditions continue to improve in many nations. Joy forecasts global growth of more than 3.5% and eurozone growth of more than 1% in 2013. Both figures are much better than forecasts for the past couple of years, and signal better times ahead. Till then, Caterpillar is dealing with industry fluctuations by reducing costs, making its services and factories more efficient, and its dealers more competitive. Cat's good times may be just around the corner.

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