After years of growth at any cost, mining companies are facing low commodity prices and something of a forced austerity shift. Over the near term, that's meant lower sales for key suppliers like Caterpillar (NYSE:CAT) and Joy Global (NYSE:JOY). Longer term, it might have even bigger implications.
A slimming giant
BHP Billiton (NYSE:BHP) has gone on a diet. It plans to cut its capital spending by as much as 25% this fiscal year, with more cuts on tap for 2015. This move is backed by the company's focus around a smaller number of core markets (iron ore, copper, coal, and oil and natural gas) and around its best properties. In fact, the EBIT margin on its core properties is around 10 percentage points better than the company's overall average.
By focusing on such opportunities, BHP can make investors more money with less spending. The company is far from alone in this effort, too. In fact, Edward Doheny, CEO at Joy Global, noted at the start of the year that, "In the last 24 months, we've seen over 25 new CEOs at mining companies take over with a focus on cost reduction and returns to shareholders after years of focus on growth and investment." Ironically enough, Joy Global's Doheny himself has only recently been granted the CEO title.
BHP truly represents the changing trends in the mining industry. However, it goes deeper than the "big picture" of cutting capital spending. Miners are looking at every expense and asking if they can save some money. Right now that means holding off on big projects, and that means holding off on big purchases like the machines that Joy and Caterpillar sell.
Joy Global and Caterpillar get a punch to the gut
On that front, Joy Global saw its mining equipment sales fall roughly 11.5% in fiscal 2013 (years end October) with bookings down nearly 23%. The latter paints a bleak picture for future sales. Caterpillar's review of its 2013 performance started with: "As we look back on 2013, it was a year overshadowed by a substantial decline in sales of relatively high margin mining products." Management went on to note that the decline was worse than expected. Following another weak performance in the first quarter, Caterpillar now expects a 20% mining equipment sales decline in 2014.
That said, in its fiscal first quarter conference call, Joy Global's Doheny said, "We are seeing signs of improvement in our service business as commodity production picks up. While commodity prices remain range-bound, the ability to delay rebuilds and service in most regions appears to be nearing a conclusion." Service bookings were up 4% year over year.
Services, including replacement parts, is one of the key reasons that Caterpillar expanded into the mining sector with purchases like the nearly $8 billion turn-of-the-decade acquisition of Bucyrus. Essentially, mining equipment wears out quickly, making selling replacement parts a reliable aspect of an otherwise cyclical business.
However, with miners looking at every cost, buying direct from manufacturer like Caterpillar and Joy Global may not be as common in the future as it has been in the past. You know exactly why: When you go back to your car dealer for service, you pay more than you would if you went to the local independent mechanic. The parts and the labor cost more because they are "approved" by the company that made the equipment to begin with.
While that has some value, miners pressed for profits may decide that it isn't enough to warrant going back to Joy Global or Caterpillar for parts and service. That could leave both companies with weaker service sales than they have historically enjoyed. This would make future profit margins, and profits, smaller than investors hope.
The big picture for Joy Global and Caterpillar is new product sales, and you need to keep a close eye on that metric. However, don't forget to monitor this pair's parts and services businesses. If the retrenching mining industry shifts gears there as well, the long-term prospects for Caterpillar and Joy Global will be weaker than you might expect.