I have been advising investors to sell their Caterpillar (CAT) holdings for some time now due to a number of issues. The company reported another set of bad quarterly results as the global slowdown is starting to really hurt the stock now. CAT management had given a guidance of $7-9 for 2013 during its Q412 earnings. Now the management has revised down its guidance saying that it will only do $7 in earnings in 2013. The stock is now trading at just ~6% above its 52 week low of $78. Given the adverse macroeconomic background, it is possible that Caterpillar may not earn even $7 in 2013 EPS.
The biggest hit to CAT's earnings came from the mining sector where orders declined by almost 50% year on year. I think that the mining sector will not come back in the next couple of years and CAT's earnings will continue to remain depressed. I think that investors should look at better industrial equipment stocks like Deere (DE). The mining sector has seen a massive boom in the last decade due to China's tremendous hunger for commodities. That boom is dissipating as China reverts to a more normal growth rate. Big mining companies like BHP Billiton (BHP) and Rio Tinto (RIO) are sharply cutting their capex and even closing existing mines. The prices of aluminum, copper, silver etc. have come down sharply over the last couple of months leading to a decline in the major mining stocks throughout the world.
Why we would still be sellers of CAT
1. Another set of bad quarterly results - CAT management during the Q412 results had said that 2013 will be a bad year and gave a very wide range of $7-9 in annual EPS. During the Q113 conference call, CAT management reduced the 2013 guidance to the lower limit of the previous range saying that it will manage only $7 in 2013 earnings. The company's performance was badly affected by the sharp slowdown in orders from the mining industry. The company's revenue fell by 17% year on year and missed the consensus estimates of $13.8 billion by 5%. The earnings miss was even bigger with the company (10% miss). What was alarming was that the company cut its inventory by $500 million in Q113 compared to the $2 billion in inventory build up during Q112.
We now expect sales and revenues in a range of $57 billion to $61 billion with profit of about $7 a share at the middle of that sales and revenues range. Our previous outlook was sales and revenues in a range of $60 to $68 billion and profits in a range of $7 to $9 a share. Mining is the primary reason for the decline in the outlook.
2. Revenue slowdown across all segments and geographies - All major industrial companies are facing tremendous problems due to the global economic slowdown. While the US market keeps rising higher, the global economy is stuck in a morass. The situation on the ground is quite bad with emerging markets like India, China and Brazil facing some serious economic issues. Revenue dropped across major segments like construction and mining as well as in major geographies like North America, Europe and Asia.
3. Valuation is not cheap and the stock can fall a lot further - CAT stock has dropped by ~15% since I wrote that investors should sell the stock. The stock valuation is not cheap at ~12x forward P/E and a dividend yield of 2.5%. I think that the stock can easily go down to $70 or below given that the company has no positive catalysts in the near future.
4. Mining slowdown is a major pain point for Caterpillar - CAT is being seriously hurt by the slowdown in the global mining sector. The price of industrial metals has resumed their downtrend after seeing a respite in the early part of the year. The recent crash in gold and silver prices was accompanied by a decline in the price of copper, aluminum and zinc as well. Major mining companies have realized that the demand from China is going to fall and have started to reduce their expansion plans. I don't expect the mining industry to recover any time soon and Caterpillar will continue to suffer from a meltdown in mining equipment orders.
We expect sales of traditional mining machines, now this would be a large trucks, large loaders, large bulldozers and the like in the aggregate to be down about 50% from 2012 and mining machines from our Bucyrus acquisition to be down about 15%.
Purchases from China, the largest buyer of iron ore from Australia, are expected to decline over the next few years as the economic growth rates slow, BHP's Chief Financial Officer Graham Kerr said."What you have seen over the last couple of years in China, I don't expect the double digit growth rates to continue," Kerr told the Bloomberg Australia Economic Summit in Sydney."Their moderated growth is around the 7 percent to 8 percent mark for the next couple of years, then trending down toward the 6 percent mark."China's economy grew 7.8 percent in 2012, its slackest pace since 1999 rate, and the latest Thomson Reuters poll puts the GDP growth rate at 8.1 percent for this year.
Stock Performance and Valuation
CAT has underperformed other major industrial companies in the last 3 months. Competitors like Deere and Komatsu (OTCQB:KMTUY) have outperformed CAT, which has given a loss of ~12% in the last 3 months. Caterpillar's valuation is not cheap with a forward P/E of 12x (assuming 2013 EPS of $7) and a yield of 2.5%. The company has a relatively high debt to equity ratio as it has a large vendor financing division.
I think that Caterpillar is a good company but faces major secular headwinds during the next few years. The mining industry is unlikely to recover, as China faces a major slowdown. The whole global economy faces serious economic risks going forward. Europe has been lurching from one crisis to the next while the Japanese government has gone over the cliff in providing a monetary stimulus to its deflation hit economy. China should also see a substantially lower GDP growth in the coming decade with much lower levels of investment. Caterpillar is going to see a severe decline in 2013 revenues and earnings which are unlikely to recover in 2014. I would advise investors that selling CAT is still a good idea right now as the stock faces large downside risks.