Caterpillar: Dim Short Term Prospects But Bright Long Term Prospects

|
 |  About: Caterpillar Inc. (CAT)
by: Balanced Investing

So far, 2013 has not proved to be a good year for Caterpillar Inc. (NYSE:CAT). After deteriorating results during the first nine months of fiscal year 2013 the company was compelled to revise its outlook. Weak demand for global mining equipment caused the poor performance of the company during the first nine months. Let us analyze how this weak demand and the performance of the other segments will affect the company's performance in the years to come.

Before going into further detail, let us briefly analyze the company's recent performance. During the first nine months of fiscal year 2013 the company's sales declined by 17 percent compared to fiscal year 2012. The decline in sales was mainly attributed to weak demand for the company's products in its mining segment. Mining machinery and equipment sales declined by $5.4 billion or 33 percent annually due to waning demand for global mining equipment.

Long Term Revival Anticipated

Demand for CAT's end-market products, especially mining equipment, will remain weak during fiscal year 2014 which indicates that the company's earnings will be further suppressed during fiscal year 2014. The company expects decent growth in the construction equipment sales, however this growth will be offset by further declines in mining equipment demand.

Weak demand for mining equipment will materially affect the company's performance in the years to come. The Resource Industries segment contributes approximately one-third to revenues. The company sells its products to dealers who in turn sell them to end users. Therefore, I believe that the company's sales are dependent upon the inventory level of the dealers. The end users are facing a low commodity pricing environment and will have to cut their production, which in turn will reduce the inventory level of dealers.

Furthermore, it is quite difficult to project the sales of a company that is operating in the mining sector because the demand in the mining sector can change quickly. By the end of fiscal year 2012 the company announced its outlook for full year sales and earnings. The company took into account low order rates from end users to project the sales and earnings. However, due to increased production from a few mining companies the company projected the sales of fiscal year 2013 to grow. However, as the year progressed, the companies reduced their mining activity which eventually led to lower sales and earnings during the first nine months of fiscal year 2013.This eventually led management to revise not only its full fiscal year 2013 guidance but also its fiscal year 2014 sales and earnings per share.

Moreover, the mining companies are focusing on controlling their operating costs through working their newer machines for extra hours which requires frequent part replacement. By adopting this strategy, mining companies are deferring new machine purchases; however, they will have to purchase machine parts in the future which will increase the aftermarket segment's sales of the company.

The global market share of Resource Industries increased significantly from 12 percent in 2009 to 33.5 percent in 2012. However, due to declining demand for mining equipment the company's global market share declined to 28.5 percent. I believe that the company's market share in this segment will remain flat in the short term, but the company's market share in the long run is expected to increase slightly from current levels because of improvements in global demand for mining equipment.

Click to enlarge

SOURCE: Trefis.com

Caterpillar's Power Systems' market share was about 5.78 percent in fiscal year 2009. This segment increased to 7.84 percent by the end of fiscal year 2012 because of higher sales and acquisitions. This segment's performance worsened during fiscal year 2013 and its market share declined to 7.04 percent by November 2013 from 7.84 percent in fiscal year 2012. Demand for this segment's product is expected to remain flat during fiscal year 2014. Therefore, I believe that this segment's market share will remain around 7 percent in the years to come.

Click to enlarge

SOURCE: trefis.com

The construction segment is the largest segment of the company. I believe that this segment's results would help the company to report decent results in the long run. Although this segment is expected to bolster the revenue of the company in fiscal year 2014, as a result of construction spending in the US and Europe this increase will be offset by a decrease in the revenues of mining equipment.

I believe that the company's revenue will surge in the long run, which will eventually ramp up the earnings of the company. Demand for construction and mining equipment, gas and diesel engines, industrial gas turbines and electric locomotives will recover because of increasing global demand for the company's products in developing economies such as China, India, and Brazil. Energy and infrastructure development will lead the demand for the company's products in the long run. Moreover, Caterpillar's focus on growing economies will lead the demand for the company's products which will not only help the company to bolster its margins, but also help the company to share its success through higher dividends.

Conclusion

The company's performance worsened during the recent term and its short term outlook appears depressing. Therefore, I believe that the company's revenue will further decline in the short term which will result in lower earnings per share. However, I would not recommend a short position as a key risk that short position holders may face is the risk that production for many of the commodity producers is expected to grow which implies that equipment orders might surge in the future.

For long term investors, I would recommend to buy the stock since the long term outlook of the company's three segments appears to be positive.

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.