The Dow Jones Industrial Average has climbed up by almost 10% YTD, whereas the shares of Caterpillar (CAT), the largest mining equipment manufacturer and a DJIA member, are down for the year. The industrial giant also slashed its EPS outlook from $15-$20 to $12-$18 for 2015; the shares have fallen by 2% in pre-market trading. In its presentation at the MINExpo analyst meeting, the company reinforced its ambitions of becoming a market leader in China. Despite major headwinds in the form of declining global mining CAPEX, and a slowdown in the European, Chinese and Australian economies, CAT is an attractive buy due to the cheap multiples at which it is trading.
CAT's management was not as bullish as it seemed to be at the same event last year, when it believed that the mining segment was going to grow as commodity demand would increase by 50% by 2020. It also forecasted that demand for iron ore and copper would grow by 75% and 70%, respectively. However, this time around, the market is bearish on the mining CAPEX. The Street estimates the CAPEX to decline by 10%-14% by 2014. JP Morgan believes that the 2012 spending represents the peak of the current cycle, at $136 billion, and a decline is expected in the next 2-3 years.
Given the deteriorating fundamentals, the market already expected CAT to revisit its last year forecasts on this event. CAT CEO Doug Oberhelman said the company is expected to make $80-$100 billion in revenues in 2015. Continued cost control and efficiency improvement is expected to raise the incremental profit to 25%. CAGR is expected to be 5%-13% for the next 3 years.
Large companies normally do not give outlooks for the next 3-4 years the way that CAT did. However, Oberhelman wanted to assure the market that the Bucyrus deal that CAT made last year is expected to reap benefits in the future; and CAT is still expected to sustain its profits after the deal. The market highly criticized the $8.6 billion deal through which CAT acquired the mining equipment manufacturer Bucyrus International, as the market believed that such a deal made no sense in a weak economy. The deal added mining shovels and drag lines to CAT's product line of trucks and excavators, and enabled CAT to become the world's largest mining equipment manufacturer. At the time of the acquisition, CAT expected benefits worth $400 million per year by 2015 from this deal through synergies of operations.
End Markets Outlook
Growth has been decelerating in some of CAT's end markets, like Europe, Australia and China. Oberhelman said that he has set a target of becoming the market share leader in China by 2015. The sales of excavators have been down 40% in China YTD. As opposed to the majority's point of view, CAT has a bullish perspective towards the Chinese economy. In a press release on August 30, CAT declared that Chinese economic growth may trigger by this year end, as the Chinese government is increasingly implementing expansionary plans like a reduction in interest rates. Joy Global (JOY) is another company that supports the idea of a recovery in the Chinese economy, as Joy CEO Mike Sutherlin believes that the Chinese economy has bottomed and is ready to turn around by the year end. CAT plans to buy ERA Mining Machinery Ltd, a Chinese mining manufacturer, in November this year. Despite this plan, the CEO said that:
"There is not another big rash of acquisition opportunities out there."
In contrast, General Electric (GE) announced in this conference that it is creating a new mining unit. GE Transportation CEO Lorenzo Simonelli said that the division was expected to acquire mining equipment manufacturers. Joy Global is a potential target for this division.
CAT acknowledges this slowdown in China, but believes that it is temporary, and the economy will be back on track by the year end. Although CAT derives only 3% of its revenues from China, it expects to gain incremental sales from this region in the future.
The outlook from Australia is also not positive. Australian iron-ore producer, Fortescue Metal Group Ltd, cut its full year CAPEX by 26% to $4.6 billion a fortnight ago. BHP Billiton (BHP), the world's biggest mining company, also delayed its projects worth $68 billion. Vale S.A. (VALE), the company with the largest budget amongst miners, plans to cut 2013 spending by 4%.
CAT's stock is a pure play on the global mining CAPEX, as it is considered a barometer for the global mining and construction sector. Among the world's 8 largest mining companies, only three have boosted their spending for this year.
Having said that, it is also to be noted that CAT still trades at cheap valuations. Most of the negative news has already been telegraphed in the stock. The stock is currently trading at a forward multiple of 8x, which is less than half its five-year historical multiple of 17x. Given that the stock trades at its historical multiple, with bearish EPS of $12 (which CAT announced in its presentation), the stock will be trading at $180 in 2015, which means a 100% upside at the current price level.