Heavy equipment maker Caterpillar (NYSE:CAT) is staring at yet another year of revenue decline in 2015 amid slowing global GDP growth, a sharp fall in oil prices, and the ongoing mining slowdown. The company expects its revenues to decrease 9% in 2015, following an approximately 1% drop in 2014, and 15.5% fall in 2013.
If Caterpillar's forecast comes true, this would be the second time in its history when the top line will fall for three consecutive years. The first time was during the 1930-1932 period of "Great Depression."
A thin ray of hope has emerged with the International Monetary Fund lifting its U.S. growth forecast, and various authorities predicting oil prices could bounce back in 2015. But it's too early to say whether Caterpillar will beat its own expectations. Here's a look at how Caterpillar is positioned in 2015.
What's behind Caterpillar's depressing outlook?
There are three key challenges facing Caterpillar:
1. Weakness in global economic growth
Caterpillar is a diversified company with global operations, and its sales outlook is linked to the world's economic growth prospects. The chart shows that, historically, the company's sales have varied in tandem with the global GDP growth.
Last month, the IMF released its global economic growth forecasts, which revealed that the global economy is now expected to grow at 3.5%, down from IMF's October forecast of 3.8%. IMF cited the "slowdown in China, looming recession in Russia and continuing weakness in the eurozone," as the main reasons behind the lower expectation.
Russia's economy could contract by 3% compared with the earlier forecast of 0.5% growth. China's GDP growth could be 6.8%, 30 basis points lower than the IMF earlier thought. Olivier Blanchard, IMF director of research, said, "New factors supporting growth -- lower oil prices, but also depreciation of euro and yen -- are more than offset by persistent negative forces, including the lingering legacies of the crisis and lower potential growth in many countries."
The U.S. is the only major economy whose forecast has been increased because of lower oil prices and strong domestic demand. The U.S. GDP could grow 3.6% in 2015 instead of the 3.1% that was expected earlier.
2. Falling oil prices
Energy and transportation is the company's largest segment, which accounted for more than 40% of the total revenue in 2014. A third of the segment's sales come from oil and gas. During the last reported quarter, revenue from energy and transportation was up 11%, primarily driven by higher demand for equipment used for well servicing, gas compression, and drilling applications in North America, and the timing of the oil and gas projects across Europe, Africa, and the Middle East (EAME).
However, revenue from oil and gas is expected to be under pressure in 2015 as crude oil prices have come down from more than $100 a barrel to around $50 a barrel in the last six to seven months. Low prices compel oil companies to cut back on capital expenses and lower production levels, which will limit the company's equipment demand. Management admits that persistent lower oil prices will have a severe impact on its results in the second half of 2015.
3. Mining slowdown
Caterpillar has been feeling the pinch on the mining front for more than two years now. Continuous decline in commodity prices has squeezed mining companies' capital expenditure, badly hitting Caterpillar's mining equipment sales. The company expects 2015 to be no different.
What could turn things around for Caterpillar?
Caterpillar derives more than 43% of its machinery and equipment sales from North America. So, the improving GDP outlook for the U.S. could be a positive for the company.
The construction industry accounts for approximately 3.6% to 4% of America's GDP. According to the U.S. Department of Commerce, construction on 1.01 million new homes was started in 2014, up 8.8% from 2013. This is the first time since the 2005 housing boom that new starts have exceeded 1 million in a year. Caterpillar's construction business in North America accounts for 16% of the company's total machinery and equipment sales.
The company is quite upbeat about the segment's growth in the U.S., though it has acknowledged that the oil price plunge will affect construction in the oil-producing states of Texas, South Dakota, and Pennsylvania.
The low oil price that is mainly responsible for Caterpillar's woes remains a wild card itself. According to the U.S. Energy Information Administration, Brent crude oil prices are expected to be at an average of $58 per barrel in 2015, higher than the present rate.
Separately, the Wall Street Journal has reported that OPEC and the International Energy Agency have said that oil prices can rebound in 2015. These predictions could take some pressure off Caterpillar.
There's no denying that 2015 will be a tough year for Caterpillar. Management and analysts are unanimous that the company could repeat the streak of revenue declines seen only during the Great Depression. However, investors should keep an eye on the U.S. construction sector and oil price movement, as these two factors can provide Caterpillar with some respite.