Caterpillar Inc.'s (NYSE:CAT) fiscal year 2013 Q4 results were in line with what investors already expected: a continued decline in sales. The company recorded a 10% fall in its revenues in Q4 2013 against Q4 2012, while for fiscal year 2013 the decline was 16%. The company noted the slowdown in global mining activities as the primary reason behind this double-digit deterioration in the top line. The outlook of the mining industry has turned into one of the focus areas of my article.
In addition to this, the company's earnings and EPS for fiscal year 2013 also dropped 33% and 32% respectively compared to the previous year. Therefore, I will also observe what the company has been doing to rid itself of this gloomy situation in the bottom line.
The company is the largest global producer of mining and construction equipment. Additionally, the company also provides financing to its customers to obtain Caterpillar equipment that includes machinery, engines, power generation facilities and vehicle vessels.
I will now analyze the outlook of the mining industry to determine the potential for the company's top line recovery. First, let's have a very brief look at how the company is dependent on the mining and construction industry.
The Materiality of the Mining and Construction Industry with Regards to Caterpillar
Source: CAT Earnings Release
The pie chart above shows that the company generated 96% of its total revenue from the sales of machinery and power systems to customers mainly related to the construction and mining industry. As a result, Caterpillar is highly dependent upon the growth of these industries for the sales of its equipment. However, the segment has registered an alarming revenue performance for the fiscal year that just ended (see table below).
The table above shows that the company reported a 16.4% decline in its sales of machinery and power systems in 2013, compared to the 9.9% growth recorded in 2012. Therefore, it is essential to have a look at whether the fall in the company's top line in 2013 will continue in the coming years or if the situation can be expected to reverse. The forecast of the mining and construction industry in the following paragraphs will make the situation a bit clearer.
Mining Industry Analysis and Outlook
After a really miserable year for the resource industry there are finally signs that the market is at the end of its slump and is forecasted to slightly recover during the next year. The recovery will mainly be triggered from global economic recovery, as businesses will begin to flourish and start new projects to cater to the improved consumer demand. On the other hand, mining companies are likely to adopt a more cautious approach with respect to incurring capital expenditure in 2014 to increase shareholder returns so that investors regain their confidence in the industry.
Construction Industry Outlook
The construction industry will receive support from the rapid increase in global urbanization over the coming years. The chart below depicts a rise in the percentage of people residing in urban areas.
Source: World Economic Forum
ARCADIS projects the global volume of construction output to rise by more than 70% to $15 trillion by 2025. This growth will be led mainly by China, India and the US who will represent around 60% of total global growth. These markets will create enormous opportunities for the financing of new assets as well as their construction. Therefore the machinery and power systems segment as well as its financing segment will receive a boost from this. However, the construction market in Western Europe is estimated to be around 5% smaller in 2025 in comparison to its pre-recession boom in 2007. Global Market Perspectives approves the positive global outlook of the construction industry. By 2050, there will be 2 billion extra city dwellers and quality urbanization will be a key construction challenge requiring the industry to discover innovative products and solutions to build better cities.
Overall, a slight recovery in the company's top line could be expected based on some of the factors I have discussed above.
Restructuring and Cost-cutting Initiatives
During a Dec. 4 2013 analyst conference, Caterpillar's vice president of strategic services spoke about the company undertaking several changes to assist cutting expenses. When the company reported its Q3 earnings in October the company's global full-time employee count was 121,506. Since then a 7,607 cut in the employee count has been made. The company is also striving to improve the productivity of its employees. This is reflected by the fact that 90% of the company's employees took only 3 weeks of paid leaves during 2013.
The company presumes around $400-500 million in restructuring costs will be made in 2014 and this has produced an estimated 2014 EPS in the area of $5.30. Analysts from Zacks Equity Research moved up their ranking of Caterpillar's stock to neutral on Jan. 17, quoting these and other cost-cutting efforts of the company as justification.
2014 Investing Outlook and My Take
The company believes its full-year revenue will be around $56 billion, plus or minus 5%, with a $0.10 improvement in the EPS to $5.85 in 2014. Considering the effect of restructuring costs EPS could decline to $5.30 in 2014. The forecast of revenue growth is on behalf of the expectations of recovery in the U.S. building industry that is expected to boost sales of bulldozers and excavators.
Based on the discussion of the mining and construction industry outlook, a bit of optimism regarding the company's top line should be a justification for holding the stock. The company is also striving to improve its bottom line and has plans to offer its investors cash returns that will also support the company's stock price in the coming years.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: The article has been written by a Blackstone Equity Research research analyst. Blackstone Equity Research is not receiving compensation for it (other than from Seeking Alpha). Blackstone Equity Research has no business relationship with any company whose stock is mentioned in this article.