Caterpillar Receives a Boost From an Unexpected Source

Caterpillar (CAT 1.59%) and its Japanese rival Komatsu are the two leading players in the global construction and mining machinery markets. Therefore, what one of them says about its end markets has direct relevance to what the other will report. Consequently, Caterpillar investors have reason to feel positive about trading in the company's third quarter. Here's why. 

How Caterpillar makes money

Caterpillar is best known for its highly visible construction machinery. Still, a quick look at a breakout of its industrial segment profit shows that its resource industries (mining and aggregate machinery) and energy and transportation segments together produced profits equivalent to its construction industries segment.

In addition, note that the profit increase in the resource industries segment is more than half the increase in the construction industries segment from 2021 to 2022 -- a reflection of the cyclicality of the resource industries segment and just how much the segment can improve profitability when its end markets are in good shape. 

Data source: Caterpillar 10-K SEC filing.

What Komatsu's management recently said

Komatsu competes directly with Caterpillar in construction and mining machinery, and its CFO, Takeshi Horokoshi, recently told the Japanese newspaper Nikkei that "there is no indication that demand for mining equipment is slowing down." Consequently, he indicated that profit growth would be more than previously forecasted for 2023 with the company pushing through price increases this year in response to buoyant markets. 

This obviously bodes well for Caterpillar's mining machinery sales in the third quarter. 

More on that in a moment. But first, it's worth recapping what Komatsu said regarding full-year guidance on its second-quarter earnings presentation at the end of July, because it has good implications for Caterpillar.

Image source: Getty Images.

Komatsu's full-year guidance

The Japanese company gives impressive detail with its guidance and breaks it out by geographic end markets and mining equipment sales. It's useful information for Caterpillar investors.

As you can see below, the guidance for overall demand for construction and mining equipment in North America hasn't changed through 2023 so far, and neither has the guidance for mining equipment. In fact, Horokoshi's recent remarks suggest a strengthening in mining machinery demand.

On the other hand, overall demand has notably weakened in Europe and China, according to the trend in Komatsu's guidance.

Data source: Komatsu presentations. YOY = year over year.

What it means to Caterpillar investors 

If Komatsu's commentary on mining machinery end markets is correct, then Caterpillar could be set for an excellent year in its resource industries segment. Meanwhile, Caterpillar's energy and transportation segment (oil and gas, power, and industrial reciprocating engines, turbines, and compressors, alongside diesel-electric locomotives in transportation) should see solid demand from buoyant energy and power end markets. 

All of which leaves the construction industries. Here, it's somewhat mixed. North American demand conditions are stable, but according to Komatsu, conditions are getting worse in Europe and China. Together, Europe, Africa and the Middle East (EAME) and Asia/Pacific (which includes China) contributed around 36% of Caterpillar's construction industries sales in the second quarter, and it's fair to say there could be pressure on the overall segment. 

Data source: Caterpillar SEC filings; *CIS = Commonwealth of Independent States.  

What's next for Caterpillar

The global economy is going through some cyclical weakness right now, and it's hard to think Caterpillar won't be negatively impacted too. That said, the strength of mining machinery and stability, for now, in construction in North America suggest Caterpillar is an industrial company that's relatively well positioned to handle it while it waits for a lower interest rate environment to boost growth.