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Summary

  • Caterpillar is restructuring one of its largest European facilities that is expected to boost this year's earnings.
  • Huge opportunities prevailing in Asia-Pacific especially in China, as it is expected to be the fastest growing region through 2017, fueled by increased mining activities and related machinery sales.
  • Expanding its Mississippi and Northern Ireland facilities to meet the probable rise in demand for aftermarket machinery parts.

Cost-saving to maintain future profitability

Mining equipment manufacturing companies are severely affected by the slowdown in the mining sector. Miners have reduced their capital expenditure budgets, hampering growth of industrial goods' manufacturing companies. This has significantly affected Caterpillar's (NYSE:CAT) financial position as it generates around one-third of its revenue from this sector and reported a year-over-year revenue decline of 16% to $55.7 billion last year. Despite this revenue decline, the company posted year-over-year EPS growth of 48% to $1.54 in 2013, mainly driven by its cost-saving strategy adopted in the second-half of last year for which Caterpillar incurred a restructuring cost of $200 million. The company reduced its workforce by 10,000 and temporarily halted operations in some factories. This restructuring reduced the company's overall cost in 2013, and Caterpillar plans to continue the same strategy this year, too. For this, the company is expected to incur an additional restructuring cost of $400 million to $500 million in 2014.

In 2014 Caterpillar plans to restructure its Gosselies facility in Belgium, one of its largest facilities in Europe. The company will refocus its Gosselies operations on final machine assembly testing and painting with limited component and fabrication operations. This will enable the company to strengthen its footprint in Europe. Caterpillar will reduce the workforce at this plant by 1,400 employees which will save around $300 million this year. Further, the company is expected to adopt several initiatives, such as plant optimization to improve the efficiency of its operations. These initiatives will cost $100 million to $200 million. However, this restructuring, is based on approval from the Belgian minister of employment. Approval is expected in the first quarter of this year.

The strategies adopted last year along with the current restructuring plan are expected to save Caterpillar $200 million in 2014 and $400 million to $500 million after 2015, further improving the company's bottom line.

Along with the cost-saving strategy, building a strong order book is also required to maintain long-term growth. This has been challenging recently, as mining companies like Rio Tinto (NYSE:RIO), Freeport-McMoRan (NYSE:FCX), and Barrick (NYSE:ABX) reduced their capital expenditure budget after evaluating the economic outlook. The miners are operating more of their newer machines rather than older ones to avoid any surge in repair and maintenance expenses and to compete with each other in the industry.

With this ongoing trend and the reduced capex budget by miners for 2014, I expect the weakness in the mining sector to continue in this year as well. The company expects its mining equipment year-over-year sales to decline by 10% in 2014. However, miners will require upgrades for machines to avoid downtime.

(click to enlarge)

Source: Factset, company report and William Blair & Company estimates

To maintain their profitability, miners are aggressively focusing on 2015 and are expecting to raise their output capacity by then. Rio Tinto is planning to raise output capacity by around one fifth to 360 million tons by 2015. BHP Billiton (NYSE:BHP) is also planning to enhance its production, while Fortescue Metals (OTCPK:FSUMF) is setting up to increase its iron ore production beyond an annualized rate of 155 million tons. This is expected to increase demand for the new machines and aftermarket machinery parts.

Also, the global mining equipment market is also forecasted to grow at a CAGR of 8.6% to reach $135 billion by 2017, which will be supported by the strong demand from Asia Pacific, especially China, India, and several other developing nations as industrial output increases.

Opportunities for mining equipment manufacturers

Asia-Pacific accounts for around 60% of the total mining equipment market. It is expected to be the fastest growing region through 2017, fueled by increasing mining production and related machinery sales in India, China, and Indonesia. Along with Caterpillar, other mining equipment manufacturers such as Komatsu (OTCPK:KMTUF), Joy Global (NYSE:JOY), Hitachi Construction Machinery (OTC:HTCMF), Sandvik AB (OTCPK:SDVKF), and Atlas Copco (OTCPK:ATLCF) will benefit from the demand from these nations. Among these nations, China is the largest purchaser (nearly 50%) of mining equipment, and Caterpillar's strong setup in China will enable it to take the advantage of the improvement in the mining sector.

Moreover, machinery demand will expand in other nations with large deposits of industrial materials, including Australia, Chile, Indonesia, and Peru. Iron ore and metallurgical coal are the two major revenue sources for Australia. Australian iron ore exports are forecast to rise by 23.3% to reach 650 million tons in fiscal-year 2013-14. The iron ore mining expansion plan by some of the world's largest producers, including Rio Tinto, BHP Billiton, and Fortescue, led the rise. In December 2013, Roy Hill, the Australian iron ore miner, borrowed around $694 million to buy Caterpillar's mining and rail equipment, locomotives from General Electric (NYSE:GE), and drilling rigs from Atlas Copco. This equipment will be used by Roy Hill to support its Western Australia project, which is expected to produce 55 million tons of iron ore annually by 2015. This will allow Roy Hill to compete with Cliffs Natural Resources (NYSE:CLF).

There are around 650 mining equipment manufacturers around the world, and the top 50 have more than 80% of the market share. The recovery in the mining sector is expected to significantly boost Caterpillar's future growth faster than its competitors, as Caterpillar is the world's largest player in the mining equipment industry followed by Komatsu and Hitachi Construction Machinery. To seize this future growth opportunity, Caterpillar expects to expand its facilities.

Expanding the facilities to meet demand for aftermarket machinery parts

To take advantage of the aftermarket sales opportunity, Caterpillar has recently planned to expand its Corinth facility in Mississippi. It will invest $14.8 million for this expansion, which will enable it to re-manufacture the C175 engine. The Corinth facility is Caterpillar's lead facility for large engine re-manufacturing worldwide. In this plant the company will repair broken or blemished machinery's parts, which will help it to fulfill the demand for aftermarket machinery parts. The company will maintain the performance and reliability of these re-manufactured parts at a fraction of the cost of a new product, while also reducing the impact on the environment.

Along with this expansion plan, Caterpillar is planning to invest $9 million to expand its truck parts manufacturing operation in Northern Ireland. The axles produced at this facility will be used in Caterpillar trucks, which are in high demand in earth-moving, mining, and quarrying machines worldwide. The company with this cost-competitive facility will enable it to serve customers cost-effectively. Moreover, easy access to ports and other transportation infrastructure facilities will add further cost advantages for the company.

This expansion plan will help the company to meet the aftermarket demand from its customers, which will enable it to capture market share more efficiently than its competitors.

Conclusion

Caterpillar is relying on cost-saving strategies and expects to generate revenue of $56 billion in 2014. The company expects restructuring will cost around $0.55 per share and forecast the 2014 EPS cost without restructuring to be around $5.85. Further, plans by mining companies for 2015 to enhance production will provide opportunities to Caterpillar as these miners will require more machines to meet their production targets. With its expansion plan, Caterpillar will serve its customers efficiently. This will support Caterpillar's future growth; however, considering its dependence on mining sector, which is expected to show recovery in 2015, I recommend a hold on this stock with a long-term perspective.

Source: Caterpillar: Betting On The Recovery In The Mining Sector