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Is Caterpillar Digging Itself a Deeper Hole?

By Rich Duprey - Apr 8, 2013 at 9:11PM

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More layoffs loom, but should investors start thinking about buying?

Just days after announcing cuts of up to 300 employees at its South Milwaukee facility that it acquired from Bucyrus, heavy-equipment manufacturer Caterpillar (CAT -4.32%) laid off 460 workers at its Decatur, Ill., plant, again citing mining industry weakness. The Decatur plant is a manufacturing facility that runs a foundry, overhaul, and remanufacturing, and where the South Milwaukee layoffs have been deemed temporary, these are said to be permanent. All told, the company wants to eliminate about 2,000 jobs.

A deep hole
Caterpillar identifies coal, iron ore, gold, copper, and oil and natural gas as primary users of its equipment, so it's easy to see why the equipment maker is taking it on the chin. Mining companies are abandoning the coal industry in droves.

Rio Tinto (RIO 2.37%) recently announced its intention to sell off its Australian coal assets while also seeking "strategic alternatives" for its copper and gold mines. Despite global financial turmoil, gold is incongruously slipping as a safe haven, as billionaire investor George Soros recently pointed out.

While I see that as a temporary response to the currency destruction being engineered by central bankers -- people only have their gold to sell to get cash, so it's depressing the price -- BHP Billiton (BHP 2.20%) is also looking to strip away things it now considers unessential to its main operations, and it has idled a number of coal mines and is looking to shed oil and gas assets because they're deemed the easiest to get rid of. Cliffs Natural Resources (CLF 0.93%) is idling iron pellet facilities because of weakness in the steel industry.

Demand an answer
As I noted over the weekend, fourth-quarter coal consumption in the U.S. tumbled 11%, according to the Energy Information Administration, and production was down 12%. It's not looking much better in steel.

The World Steel Association says that while China's crude steel production jumped nearly 10% in February, it was down almost everywhere else in the world, with the U.S. experiencing an 11.8% falloff, amounting to a 1.2% global increase in production. But with demand falling, we're going to see weak pricing rule the day.

While natural gas prices have rebounded in recent weeks to above $4 per million Btus, they fell again last week, settling right at $4 at Henry Hub but down to $3.90 on the NYMEX. And as mild weather spreads across the country, it's likely they'll fall below that threshold again, even as the number of natural gas rigs in operation has dropped below 400 for the first time since 1999.

Strength in numbers
Joy Global
(JOY) is the world's second largest mining-equipment manufacturer, and it relies even more so on the coal industry's health than Caterpillar does, with two-thirds of its sales coming from coal miners. It cut several hundred jobs late last year, and in its first-quarter conference call in February, the equipment manufacturer pointed to a 27% decrease in books, as original equipment orders dropped 30% and it saw aftermarket orders cut by a quarter.

Both Caterpillar and Joy Global have lost around 20% of their value over the past year, and the outlook for the industry seems bleak. Yet these are companies in cyclical industries, and the time to buy such stocks is when things look darkest. They might not have reached their nadir just yet, but they're both becoming attractively priced, warranting their addition to your watchlist.

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Stocks Mentioned

Caterpillar Inc. Stock Quote
Caterpillar Inc.
CAT
$197.82 (-4.32%) $-8.94
Cliffs Natural Resources Inc. Stock Quote
Cliffs Natural Resources Inc.
CLF
$21.79 (0.93%) $0.20
Joy Global Inc. Stock Quote
Joy Global Inc.
JOY
BHP Group Stock Quote
BHP Group
BHP
$67.32 (2.20%) $1.45
Rio Tinto plc Stock Quote
Rio Tinto plc
RIO
$69.54 (2.37%) $1.61

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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