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The last couple of years have not been very kind to Caterpillar Inc. (NYSE:CAT). After a poor performance in the third quarter of the fiscal year 2013, Caterpillar revised its future guidance for the fourth quarter as well as for the fiscal year 2014. I aim to identify the factors behind the poor performance in the third quarter of the fiscal year 2013. Moreover, I have studied the future prospects of the company in order to determine whether or not it presents itself as a profitable investment opportunity.

Financial outlook

The company reduced its 2013 outlook after the weak results of the fiscal year 2013. What are the factors that put pressure on the top and bottom lines of the company?

The company announced third quarter sales and revenues of $13.42 billion. This is a decline from $16.45 billion earned in the third quarter of the fiscal year 2013. This year has proven very difficult for the company that posted a decline in its expected sales and revenues of $11 billion, which is approximately 17 percent YoY. A 75 percent of this drop is sourced from the resource industry, which is a major source of revenue for the company.

The company anticipates a decline of approximately 40 percent in the resource industry during the fiscal year 2013. The sales of the power system and construction industry are expected to decrease by about 5 percent during the fiscal year 2013.

As a result of low sales volume in the fiscal year 2013, the company was compelled to revise its 2013 outlook. The previous outlook for 2013 sales and revenue was in the range of $56 - $58 billion with earnings per share of about $6.50. However, because of waning demand for mining equipment, the company revised its 2013 sales and revenues to around $55 billion with profit per share of about $5.50.

The company produced $60.1 billion in sales and revenues in 2011. However, according to its guidance, the company might not be able to replicate these results until 2015. Caterpillar's current guidance for the next two years indicates a razor sharp decline in the company's net profit.

Caterpillar is facing a tough year as compared to results of the last couple of years. Due to lower prices of mined commodities and the associated volatility, Caterpillar is facing a waning demand for mining equipment. As per the company's corporate press release:

Caterpillar has taken substantial actions and is mitigating some of the impact of lower mining sales on profit. The company expects to limit the decline in 2013 operating profit from 2012 to about 30 percent of the sales and revenues change. This is at the high end of the company's incremental operating profit pull through target range and is a result of unfavorable product mix as the sales decline is weighted toward higher margin mining products.

Slow economic growth and weak demand for mining equipment

In the fiscal year 2014, the sales and revenue of the company are expected to be in the range of a negative 5 percent to a positive 5 percent than the fiscal year 2013. This is due to low mining machinery orders despite higher mine production around the globe. The uncertainties concerning global economic growth, the U.S. monetary policy and Eurozone recovery further add to the company's turmoil.

The growth of the mining industry depends upon both the US and world economies. The GDP in the US is expected to grow at an annual rate of 2.4% in the near term. The global GDP growth is estimated to grow at an annual rate of 2% over the next several years. Therefore, I believe that the industry will experience slow growth in the long run.

Moreover, demand from the mining industry is difficult to forecast and is very dependent upon customer preference for certain projects. BHP Billiton Limited (NYSE:BHP) and Rio Tinto Group (NYSE:RIO) are also among the companies that have curbed billions of dollars of capital spending.

Business strategy to cater to weak demand

One of Caterpillar's key strategies is to focus on curbing costs during turbulent times. The decrease in sales in 2013 resulted in decreased production, costs and employment. The company has already taken certain steps in order to cater to the volatile demand. The company has already closed a few production plants. Moreover, Caterpillar has fired more than 13,000 employees (about 7,500 full time employees and 6,000 part time employees) in the last year or so.

Furthermore, the company has also cut down its capital expenditures. By taking these steps, Caterpillar is trying to mitigate the impact of lower mining sales on the company's profit. Moreover, Caterpillar is also expected to further reduce its inventory in the last quarter of the current fiscal year.

Year-to-date, excluding the impact of inventory absorption, the company has lowered costs by $700 million and capital expenditure by about $400 million. Moreover, analysts are expecting a 12% decline in the capital spending of major mining companies over the next two years owing to a wane in demand for mining equipment.

Though the company has continued to improve its operational performance this year the improvements are overshadowed by the decline in demand for mining equipment due to low commodity prices.

The company's year-to-date sales were up in China and included an increase of 30 percent in the third quarter of the fiscal year 2013. However, sales were down 24 percent in the Asia Pacific region in September due to a low demand for construction equipment in China.

Despite the higher number of mining projects around the world, the number of new orders remains low. Since the macro economic factors are beyond the control of the company it is highly unlikely that the company will be able to report a decent margin when global demand for mining equipment is waning.

Conclusion

The company tried to improve margins in the third quarter of the fiscal year 2013 by curbing costs; however, a decline in the sales of mining equipment, due to lower commodity prices, means that the company will not manage to report decent results. The demand curtailment affected the company via the segment that contributes most to the company's sales and margins. The company's rebound depends on the global demand recovery, especially the mining equipment demand from Asia that realized a 63% YoY decline this quarter.

Moreover, slow economic recovery and continued low demand for mining equipment will prevent the company from reporting decent margins in the near future. Weak demand for mining equipment in China will also put some pressure on the margins of the company in the future. Therefore, keeping in mind these factors, I would recommend selling the stock.

Source: Things Are Falling Apart For Caterpillar