Caterpillar: Why I Would Remain On The Sidelines

| About: Caterpillar Inc. (CAT)
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Summary

Construction and mining equipment makers like Caterpillar are going through a tough phase.

Caterpillar shares though have done well over the past 12 months.

The company also reported better-than-expected earnings in its most recent quarter, driven by cost cutting measures.

However, Caterpillar and the wider industry face major headwinds.

Construction and mining equipment manufacturers have been through a difficult phase in last three years as they have been weighed down by a pullback in orders due to a sharp decline in mining and construction activities since late 2012. The slowdown, which has followed a decade-long boom, has had a negative impact on top-line growth of the likes of Caterpillar Inc. (NYSE:CAT). Still, Caterpillar shares have performed strongly in the last 12 months, gaining nearly 20%.

Earlier in October, shares climbed about another 5% after the company posted better-than-expected quarterly earnings, stretching gains to around 25% over the last one year.

While surprising earnings results - thanks to Caterpillar's aggressive cost cutting measures and robust demand from energy and construction industry in the North American region - bolstered investors' confidence, they also rejoiced after the company released an upwardly revised outlook for 2014.

Moreover, the Peoria, Illinois,-based company provided a cautiously optimistic outlook for 2015, citing an increase in infrastructure projects spending by the U.S, India and Turkey.

But that strong-run, however, came to a halt late in November. Caterpillar's shares tumbled after the company's latest 8-K filing showed that total machine sales fell 9% for three months rolling period ended in October.

And that's not surprising. Caterpillar, which generated about 61% of its revenue from markets other than North America in 2013 according to Bloomberg estimates, is facing several headwinds.

The Headwinds

The Chinese economy, which fuelled the commodity boom until 2011-12, is now showing signs of a sharp slowdown. A spate of dismal economic numbers in the backdrop of weakness in factory orders and construction industry has made the jittery People's Bank of China cut interest rates. Speculation is rife that more rate cuts are on the cards. Time will tell whether the Chinese economy will regain momentum. However, weakness in the Chinese economy has badly hurt the commodities-driven economies like Brazil and Australia.

Earlier in November, the Aussie dollar plunged to a four-year low against the U.S. dollar as ongoing turmoil in commodities prices amid falling demand growth for raw materials in China put pressure on the currency. The turmoil in the commodities markets made J Morgan to slash its GDP growth forecast for Australia to 2.8% from 3.3% in 2015.

Latin America, another major region whose economy is heavily dependent on commodities exports, is now struggling due to a meltdown in raw material prices and depreciating currencies. During the commodity boom, Latin America economies prospered while higher interest rates also ensured heavy capital inflow. Now, with rising interest-rates in the U.S., the Latin American economy is finding it hard to attract capital. Moreover, softening commodity export prices has deepened the region's current account deficit, resulting in a sharp depreciation of currencies.

Earlier in November, Financial Times reported that foreign investments during the first half of 2014 dropped by 23% compared to 2013, mainly due to a slowing down in mining investments.

Falling investments on mining activities can be gauged by Caterpillar's total machine sales in Latin America, which fell 35% for the three-month rolling period in October while in Asia Pacific it dropped by 21% for the same period.

The Bottom Line

Caterpillar recently stated that it expects an increase in infrastructure spending in the U.S., India and Turkey. And that was the reason why the company projected flat to slightly higher sales for fiscal year 2015, in the most recent concluded quarter.

However, other markets such as China and Latin America are showing worrying signs. A challenging macroeconomic environment would mean that companies would continue to spend guardedly on capital investments, which would eventually hurt Caterpillar's orders-book and the top line.

In the medium-term, Caterpillar shares will be subject to immense pressure. As an investor, I would therefore remain on the sidelines.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.