Global equipment manufacturer Caterpillar (click ticker for report: ) posted weak first-quarter results on the back of a decline in global mining capital expenditures. Revenue dropped 17% year-over-year to $13.2 billion, which was slightly below consensus expectations. Earnings tumbled 45% year-over-year to $1.31 per share, which was also worse than consensus estimates.
The decline during the first quarter wasn’t much of a surprise as the outlook for mining capital expenditures fell precipitously as commodity prices tumbled. In fact, Cat’s revised outlook implies a 50% year-over-year decline in sales of the firm’s traditional mining equipment and a 15% decline in sales of the equipment sold by recently-acquired Bucyrus. Sales fell 23% in the resource segment for the quarter, and with most of the global mining giants like Rio Tinto (click ticker for report: ), BHP (click ticker for report: ), and Anglo American dealing with new supply coming on line as prices remain weak, a sharp rebound in this part of Cat’s business shouldn’t be expected. Naturally, we think this news looks bearish for competitor Joy Global (click ticker for report: ), which relies mostly on mining activity to generate revenue.
On the other hand, Cat’s bearish outlook for mining sales could be bullish for the diversified miners because the firms may slash capital expenditures at a more aggressive rate than anticipated (supporting pricing). Still, supply remains the largest threat to robust profitability across the mining industry because significant mining supply is coming on line at Rio, Vale (click ticker for report: ), and Anglo American’s Minas Rio project. In effect, large amounts of iron ore could come to market at the same time demand growth may moderate to reflect less robust growth from China. While certainly a valid concern, these fears may be slightly overblown and underestimate other emerging markets’ role in consumption. Further, Chinese real estate steel demand growth may decelerate, but the country will still add several millions of cars to the road over the next decade. We continue to pay close attention to the mining space.
Caterpillar’s construction business was also weak, as sales fell 17% year-over-year to $4.2 billion. Sales in North America declined 14% to $1.5 billion, which was stronger than the 17% decline in the Asia-Pacific region and the 23% decline in EAME. We think continued strength in the US housing market could provide a positive catalyst, but it is important to recall that the company boosted dealer inventories last year, so sales growth might not translate immediately. Nevertheless, we do not feel as bullish about a recovery in Chinese construction; another key lever for Cat’s growth.
With regards to China, management provided what we believe was fairly bearish commentary, saying:
“I am pleased to report this morning that we along with our dealers have made quite significant progress in lower inventory. Dealer machine inventories declined throughout 2012 and are currently at reasonable levels relatively to sales.
In terms of our inventory, that’s Caterpillar finished inventory in China, as expected it declined during the first quarter. While inventory reduction is expected to continue into the second quarter, we do expect to begin increasing production in China during Q2.”
We tend to agree with this outlook, and in our view, the read-through seems to suggest current demand remains sluggish. If China remains weak, the impact on Caterpillar could be painful. Not only does China account for a significant amount of revenue directly, but the country also accounts for a large portion of resource consumption growth. When China doesn’t buy resources, mining firms don’t need to purchase new mining equipment, which clearly would have a negative impact on Cat.
Power systems proved to be the most resilient segment in the first quarter, falling 12% year-over-year. Order trends were pretty mixed. Fracking and drilling were weak, but compression, the other component of oil & gas, saw orders increase. Caterpillar also noted that rail and solar performed well.
Looking ahead, the firm reduced its guidance for revenue to the range of $57 billion to $61 billion, generating earnings per share of $7. This guidance was well below consensus expectations, but it is not surprising given the current outlook for the global mining industry. We do not see much upside to the forecast in 2013 given the sluggish growth of the global economy.
Ultimately, Caterpillar’s quarter wasn’t good, nor was its guidance at all positive. As a result, we continue to believe shares look fairly valued. Cat’s business is highly cyclical, and therefore, we demand a significant margin of safety before getting comfortable with adding shares to the portfolio of our Best Ideas Newsletter.