Here's How North America Is Helping Caterpillar Weather the Storm

Construction machinery sales have slipped across the globe, except in North America. Will the region be Caterpillar’s saving grace?

Jul 21, 2014 at 2:09PM

The world's biggest heavy equipment maker, Caterpillar (NYSE:CAT), has seen depressed sales growth as a result of the mining sector around the world taking a bad turn. Understandably, investors were worried when the company reported a steep decline in its machine sales last month. The one thing that's helping Cat's case is its construction segment, which is doing brisk business, especially on the company's home turf. With the second quarter earnings release right around the corner (July 24), let's check out how North America's (and mainly the U.S.) construction sector is helping to lift the company's plummeting sales and keep profits at a decent level.

Strong headwinds and the lone bright spot
Cat's global dealer sales, a barometer for global construction and mining equipment demand, have remained low through the first five months of the year. Sales were down 12% year over year in May, marking the third straight month of double-digit declines. As expected, mining remains the main culprit, with sales down 46% in May as the situation in Asia (down 69%) and Latin America (down 62%) shows no signs of recovery.  

To add to its woes, Cat's energy and transportation sales are also down on the back of weak power generation and transportation demand. Despite an easy comparison of 10% decline in May of last year, power sales slipped by 13% in May 2014. We will get more clarity on industrial demand when General Electric reports its earnings on July 18.

Source: Bloomberg

Amid all of the uncertainty, North America has been Cat's ray of hope. In May, sales jumped for the fifth consecutive month and were up 14% year over year. One big positive was that mining sales finally reversed their downward descent and posted the year's first rise, growing 7% year over year; this was helped by a stabilization in U.S. thermal coal. The real boost came from construction, however, which posted a 17% increase. Quite remarkably, the company has been generating sizable revenue for its construction segment back home.

The visible upswing in North America
One of the major indicators of construction equipment demand in the U.S. is the American Institute of Architects' Architecture Billings Index (ABI). The ABI helps to predict non-residential construction activity in the following nine to twelve months, and a score higher than 50 means increased billing or expansion. As per a Bloomberg report, the ABI leapt to 52.6 in May, the highest level seen since September 2013; maximum strength was seen in the South and Midwest, with readings above 50.

Source: Bloomberg

A quick glance at the chart below shows that Caterpillar has been a direct beneficiary of the U.S. upsurge. Construction sales in the U.S. have shown double-digit increases in the first five months of the year. The company is doing all that it can to continue this momentum. It's been focusing on the Tier 4 product development program, and at the CONEXPO held in March at the Las Vegas Convention Center it talked about its integrated technologies and fuel efficiency advancements that would drive demand for its products.

2014 Construction Machinery Retail Statistics, Source: Caterpillar

Increased guidance
Cat's management is upbeat on the growth of the construction industries segment, which contributed nearly 38% to its first quarter revenue. The optimism came through clearly when the company increased its construction business sales guidance for the year from 5% to 10%. 

Sales improved by 36% in North America in the first quarter as compared to the year-ago period. Though European and Chinese markets also showed decent sales hike of 20% and 10% respectively, Cat is cautious about these regions' GDP growth over the coming months. Europe's recovery is moving at a slow pace, with its GDP growing at a rate of 1% annually. Cat anticipates that China's GDP for the year to be the same as last year's 7.5%. China's construction equipment demand is weakening, as seen in May when excavator sales experienced the worst decline in 15 months at 31% against the corresponding period of last year. Cat's construction equipment sales fell 5.7% in the country in the same month.

All eyes are now on North America, and Cat's top brass are expecting to meet their yearly forecast through the region. North America alone accounts for more than 40% of the segment's sales.

The bottom line
Caterpillar is in the thick of things. On one hand, a crucial market like China is facing demand slump, and on the other, construction activity in North America is strengthening. This is in line with the company's raised guidance for the segment. While the bellwether takes steps to fight the odds, the U.S. recovery is a godsend. Suffice it to say, Cat will make the most of it.

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ICRA Online and Eshna Basu have 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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