We have all seen them. When you drive through town and you pass a construction site, nine times out of ten you will see a piece of equipment with their name on it. Their iconic yellow machinery makes it easy to distinguish them from the competition. Caterpillar (NYSE:CAT) has been making machinery for over 85 years and their consistent earnings demonstrate the quality and success of their business. With an IPO in Q3 of 1977 of just over $6 per share, the current price at almost $90 per share, and three 2:1 splits since IPO, it has historically performed exceptionally. The company has consistently declared dividends every single quarter since Q2 of 1986. Over the past 4 years, their net income has increased by a factor of five and the current return on equity of the company is a spectacular 32% while in comparison, most strong companies are hovering around 15%. However, construction equipment isn't the only thing that Caterpillar gets their hands dirty with. They finance and insure their equipment in-house, allowing them to adjust the terms of their lending to fit the changing needs of their customers. This is an especially powerful tool for Caterpillar.
The most interesting part of the changing global climate and their growth strategy is the increasing demand for mining. This could prove to be a future gold mine for Caterpillar owners and shareholders. Many countries around the world rely heavily on mining to support their economies. For example, eight percent of the GDP of Australia consists of the mining industry. Mining provides thousands of jobs not only to Australia, but to a number of other countries as well. Research done by the University of British Columbia shows that the mining industry grew by 21.5% in 2011, reaching a value of $2,997 billion and is projected to grow to $4,998 by 2016. Caterpillar has a large line of mining equipment including large mining trucks, draglines, belt systems, drills, and hydraulic shovels. This equipment and technology positions the company in a powerful seat in the market. Their presence is so large that they host a MineExpo to showcase all of the current and new product lines that they carry. Caterpillar is in a unique position to profit tremendously from the future of the mining industry. The demand for mining will only continue to increase along with the earnings of Caterpillar.
Along with the abundant opportunities at the doorstep of Caterpillar, there are also threats in the marketplace. One of the major long-term threats to the success of Caterpillar is the increase in renewable energy around the globe. Coal is a large part of the mining industry and Caterpillar maintains a large portion of the market share for that mining equipment. In 2011, about 9% of America's energy came from renewable sources and accounted for about 13% of the electricity produced according to the Institute for Energy Research. The expected growth rate of the renewables is estimated at 2.9% a year globally, which could affect the demand for coal and the need for mining. This is especially true in the Asia-Pacific region, which accounts for about 65% of the mining industry in the world. Countries like China are going through industrial revolutions right now and are making large investments in renewables such as wind and hydro-electric power. China recently completed The Three Gorges Dam, which produces a massive 22,500 megawatts of electricity. Though this is the largest hydroelectric dam on the planet, it currently supports only 2% of the total electricity demand in China. That percentage would have been much higher if the demand for electricity had not grown as quickly as it did. America also has the potential to provide up to 30% of its demand with wind energy, according to the U.S. Department of Energy. The only barrier to this growth in renewables is the price and availability of the technology to implement these changes in energy infrastructure. As these factors change, the amount of growth in the sector will change along with it. The potential for renewables is enormous and is continuing to expand, which could potentially be a minor threat to the future of Caterpillar. Another potential risk to Caterpillar is the decrease of federal spending in the United States. The future of how spending will be allocated is very unsure. If the government is allotting less funding to states for roads and new building construction, the demand for machinery in the public sector could be at risk.
One more factor that is very important to consider for the long-term success of Caterpillar is their corporate governance. Corporate governance can either make or break a company. With poor leadership, even the strongest company can go bankrupt in the blink of an eye. It is important to consider how a company handles growth and acquisitions of new business ventures. The acquisition of the ERA Mining Company in China is a prime example of a mistake in a new marketplace. The company was bought by Caterpillar as part of their bold foray into the Chinese market. Caterpillar first had issues with the Sany Heavy machinery company mimicking their technology, effectively destroying their market share by 30%. To make matters worse, ERA was found to have committed accounting fraud by fixing their records. All of these factors could threaten their reputation as a company and as a brand. The ERA Mining Company may be somewhat of a naïve venture gone wrong, but it is certainly something they can bounce back from. Not learning from blunders like the situation in China is what causes companies to go under, and it's clear Caterpillar will not make the same mistakes twice.
Overall, Caterpillar is a very solid company. Not many companies continued to pay dividends from 2008 to 2011, even when the stock price fell from around $82 to a low of about $23 in the middle of 2009. They have proven time and time again that they have the resolve and solvency to carry on through some of the roughest storms. The company continues to improve and evolve to the needs of their customers and the industry. The threats facing the company are equally as large as their opportunities. Caterpillar is poised to continue as one of the most financially sound companies in the marketplace, but their success depends on a number of changing factors.
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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: This article was written by an analyst at Catalyst Investments.