Demand for Caterpillar's (NYSE:CAT) construction equipment and machinery has been slipping globally since the last quarter of the 2012 fiscal. Slump in global demand for mining operations has sent a ripple effect across the top 10 mining companies impacting their global operations. As a result capital expenditure for these corporations including Caterpillar Inc. is predicted to fall another two years.
A soft outlook on three of the biggest mined commodities coal, gold and copper has made investments unlikely to rise in the next few quarters. Fueled by China's massive economic expansion, extraction of these specific minerals peaked during the 2011 fiscal. However, it was all downhill from there onwards. Prices of copper, calculated by the S&P GSCI Copper Index, and Gold, measured by CBOE Gold Index fell by 60% and 59.2% respectively. Prices of coal have suffered an even bigger dip falling 72% in the Dow Jones Coal Index since 2011.
To ascertain why the above mentioned descent occurred and how it triggered a reduction in capital expenditure by mining corporations, it is important to take a closer look at two key factors: China's enormous coal inventory and the US's preference for natural gas.
Chinese Coal Reserves
Apart from being the world's leading producer of commodities, China is also the largest producer of coal. To further reform their economy the country has shifted its focus from manufacturing - a segment it prides itself on - to a more customer-driven system. Implementation of the new strategy has caused a few cracks in an otherwise invincible economy thus causing a 2% drop in GDP growth in 2014.
According to the National Development and Reform Commission or NRDC - a Chinese macroeconomic firm - the shift in its economic approach has caused a massive accumulation of coal reserves in the country. According to estimates coal producers in China had about 100 million tons of unsold coal in their stockpile at the end of the last quarter.
US' Preference for Natural Gas
The power sector in the US consumes about 93% of the total coal produced in the country. In a bid to ensure a healthier and greener environment the US has been switching over to natural gas as the primary energy producing ingredient instead of coal. As a result, the US Energy Information Administration or the EIA expects coal consumption to fall approximately 3% in 2015. Plummeting demand is expected to impact coal production as well.
How this affects Caterpillar
Caterpillar Inc. is among the leading producers of mining tools and machinery which is used to extract coal and other such commodities. The mining sector's expenditure exists either in the shape of new mines or expansion of ongoing operations. This basically measure that capital expenditure is of vital importance for manufactures like Caterpillar Inc. since expenditure made by the mining industry translates into revenue for the machine maker.
Why CAT Remains a 'Buy'
Caterpillar Inc. has been a dominant player in the engineering and construction goods industry since 1925. The company is placed among the elite Fortune 500 club and its stock is a vital component of the DOW Jones Industrial Average. Those stats alone speak volume for the leading earth moving company that continues to innovate construction and mining gear.
Despite experiencing a slump in global mining operations, the company has showed signs of positive investment measures and has displayed strength in several financial areas. CAT's stock continues to remain solid along with earnings per share, return on equity and net income. Not only did the stock rise at a fast pace in the last fiscal quarter, it did so faster than the S&P 500 - an indication of earnings growth. Earnings per share increased 8.3% compared to same quarter one year ago. Net income peaked by 4.1% in the last quarter which is an increase of approximately $40 million.
Though Caterpillar had to endure a sharp decline in its revenue, the company did, however, do better than the industry average of 3.6%. The waning had little effect on the company's bottom line, with EPS growing notably. In addition the company firmly believes that its cash flow is not only vast enough to pay the bills but also leave ample room to elevate cash return for stakeholders.
Considering all the above mentioned factors and the fact that a single global mining project from an emerging new market can breathe new life into the company's revenue, analysts predict that Caterpillar's stock will continue to reap benefits for its stakeholders.
Disclosure: The author is long CAT.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.