The last couple years haven't been very kind to Caterpillar (NYSE:CAT). While the rest of the market has been rallying on free money from the Fed and other central banks, this didn't reflect nicely on Caterpillar. The company continues to suffer from weak demand in the mining industry as prices for many materials continue to be weak despite endless currency printing around the world. If miners can't make money on the things they mine, they can't buy new equipment and if they can't buy new equipment, companies like Caterpillar can't see much growth. This is exactly what we've been seeing for the last couple years.
After posting weak results in the third quarter of this year, Caterpillar reduced its future guidance for the next couple years. For 2013, the company expects to generate $55 billion in revenues and $5.50 per share in net profit, which is a downgrade from the previous guidance of $57 billion in revenues and $6.50 in net income. Caterpillar sees things improving a little bit in 2014. However, the guidance is somewhat blurry and subject to change. In 2014, Caterpillar expects its revenues to stay relatively flat in comparison to 2013, with a 5% error rate. Basically, the best case scenario calls for 5% revenue growth and the worst case scenario calls for a 5% revenue decline for the company as we move forward. In 2012, Caterpillar generated $65.9 billion in revenues, which means that the company will be seeing a sharp decline in the next couple years compared to its 2012 performance. Even in 2011, Caterpillar was able to generate $60.1 billion in revenues, which the company might not be able to replicate at least until 2015 according to its guidance. As for profits, the company generated $7.40 per share in 2011 and $8.48 per share in 2012. Caterpillar's current guidance for the next two years represents a sharp drop in the company's net profit.
All over the world, there are many uncertainties that will play a role in how Caterpillar acts. For example, no one knows how the Fed and other central banks will be shaping their monetary policies in 2014. While a lot of people expect a slowdown in the Fed's aggressive easing policies, it is difficult to predict the rate of slowdown as the American job market is far from recovered even though the country's stock market is near all-time high levels. The price of gold and other materials also continue to be highly volatile and it is very difficult to predict how many mined-materials will act in the next year. Caterpillar's performance will also depend on continued construction activities around the world. While the Chinese continue their massive constructions with printed money and the Middle Eastern countries spend their oil money on upgrading their infrastructure, the rest of the world may not see much growth in the construction sector in the near term.
Caterpillar is working on becoming more agile in the face of weakening demand. The company is learning to control its inventory levels to match the demand. Just a couple years ago, Caterpillar's biggest issue was not having enough production capacity but things turned upside down quickly enough. In order to address volatile demand levels, the company will also have to adjust the number of employees it has. In the last year or so, Caterpillar reduced its workforce by 13,500 employees (about 7,500 full-time employees and 6,000 "flexible" employees) and it closed down a few production plants that were opened for ramping up production rates when the demand was so high and the company couldn't keep up with it. In the third quarter of this year, Caterpillar reduced its dealer machine and engine inventories by about $800 million and it is expected to reduce its inventories further in the fourth quarter. Caterpillar still sits on a backlog of $19.1 billion, but this number is likely to decrease in the next year as demand continues to be weak.
Between 2012 and 2013, Caterpillar saw lower revenues in every geographic region it operates in. This year, the company's North American sales fell by 14%, Latin American sales fell by 12%, European and the Middle Eastern sales fell by 14% and Asian sales fell by 30% compared to 2012. The Resource Industries (the segment of Caterpillar that sells machinery to the mining companies) saw its revenues drop by 42% during this period and Asian sales of this segment fell by 63%. Caterpillar's two other segments, Construction and Power Systems, saw their revenues fall by 7% each, which is not as bad as the Resource Industries segment. These two industries are not as volatile as the mining industry and they are expected to move in single-digits for the foreseeable future.
On a positive note, Caterpillar continues to be highly profitable. This year will be another year of strong positive cash flow for the company. As of the last quarter, the company's cash and short-term investments totaled $6.3 billion. In the first 9 months of the year, the company generated $867 million in positive free cash flow after accounting for dividend payments (roughly $730 million year-to-date) and stock repurchases.
Currently, Caterpillar trades for 13 times its earnings (the industry average is 12), 3 times its book value (the industry average is 2.9), 0.9 times its sales (the industry average is 0.8), 7.2 times its cash flow (the industry average is 11), and it has a dividend yield of 2.6% (the industry average is 1.9%). Given that the company won't see much growth in the near term, we can say that it is fairly valued. Currently, buying Caterpillar would be betting that the mining industry will see improvements. It is difficult to see how the mining industry will perform in the next few years when we consider the fact that it underperformed the market due to weak mined-material prices despite the endless money-printing across the world. I don't expect Caterpillar to move much in either direction until the mining industry's performance changes drastically in either direction (which will depend highly on mined-material prices).
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.