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Here's Why Caterpillar Is a Solid Long-Term Investment

May 30, 2014 | About:
jaggom

jaggom

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The mining industry suffered in 2013. The macroeconomic slowdown that results in weak commodity prices has created a situation of overcapacity for the industry. This is a negative factor for mining equipment and machinery makers such as Caterpillar (CAT) and Joy Global (JOY) which have displayed pathetic performance. The quarterly results for both were weak last time, and they also issued weak guidance. Going forward, none of them expect any relief stepping into the New Year.

Caterpillar in Trouble

Caterpillar suffered tremendously in the past. Its latest third-quarter results add to the already pathetic condition. The sales dropped $11 billion from last year and earnings declined 44%. According to Brian Langenberg of the Langenberg research firm, "The third quarter was ugly, the fourth quarter will be worse and the guidance for 2014 is very, very submissive."

Caterpillar reduced its full-year forecast as well in light of the terrible performance and expected weakness in the end markets. Its sales forecast for 2014 clearly indicates that weakness from mining customers would continue impacting its results. Also, according to Caterpillar CEO Doug Oberhelman, "The company has no plans of expansion in the near term and it's not going to happen."

Further, Caterpillar recently declared a 12% drop in global retail sales for the three months ending in November 2013. Hence, everything looks dark for Caterpillar.

Joy Global’s Woes

Very similar to Caterpillar, Joy Global is also in distress due to oversupply in its end markets. Last year, the global consumption of coal jumped 2% to 7.84 billion tons whereas production only increased 3% to 7.88 billion tons. Moreover, coal consumption growth in China was expected to have slowed down to 4% year on year in 2012, down from 10% in 2011. This resulted in a surplus in coal supplies ultimately pressured pricing. The lowered pricing forced mines to start deferring capital expenditures which badly affected both Joy Global and Caterpillar.

As a result, even though Joy Global's third-quarter results exceeded the consensus estimates on earnings, investors are still negative about its prospects due to the decline in earnings and revenue from last year. The loosening of the order book for Joy is another concern. The adjusted earnings for Joy Global of $1.70 per share in the previous quarter were down from $1.87 in the year-ago period. The company’s revenue in the reported quarter at $1.32 billion was down 4.9% from $1.39 billion last year, primarily due to weak sales in the underground mining segment.

Is a Recovery in Sight?

The global mining equipment market growing at an annual rate of 8.5% is expected to be worth $117 billion by 2018. Surface mining equipment masters the biggest chunk of the pie for this market at nearly 37%, followed by underground mining equipment. The Asia-Pacific region is forecast to be the quickest-growing area in the coming years, fueled by increasing mining production and related machinery sales in India, China and Indonesia.

There are conflicting opinions over growth projections in the open-cast mining sector that involves iron ore. Australia being the largest iron ore exporter, forecasts exports to increase 14% in the ongoing fiscal year. But again, oversupply remains the main concern here as well, which could fuel weakness in pricing due to loss of growth momentum in China and India.

The economic recovery in major commodity markets is probably going to be a very slow process and hence, the growth in commodity demand will also be weak. This is further supported by the fact of reduction in capital expenditures by the mining industry in general.

In such hard times, Joy Global and Caterpillar are trying hard to keep investors happy through share repurchases and dividends. For example, Caterpillar has repurchased $2 billion worth of stock this year and raised the quarterly dividend by 15%. Joy Global has also announced a share repurchase program of $1 billion over the next three years.

But, Joy Global has a debt to equity ratio of 0.46 versus 2.18 of Caterpillar from the investment point of view. And it has a P/E of 11 depicting a cheaper stock when compared to others such as Caterpillar (17 times earnings), and this is the reason investors must value and definitely consider Joy Global.

Where to Invest

Both Joy Global and Caterpillar are facing tough times, and recovery cannot be expected in the near future as well. Therefore, investors planning to invest in these companies at their current levels must wait patiently. Further, management is trying to keep investors happy through dividends and buybacks. But for those investors looking for a really cheap option, Joy Global could be an ideal choice. The stock has yield of 1.30% and a trailing P/E of just 11.4. The stock has dropped almost 37% this year and might be a good option for the long run.


Rating: 1.5/5 (2 votes)

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Comments

phelanmt
Phelanmt - 2 months ago

Nothing you said explains why CAT is a good long-term investment.. Just why it isnt a good short term investment.. click-bait title.. The icing on the top of this crap artivle is your recommendation of JOY over CAT at the end. Completely contridicting your title.. Does Gurufocus have editors?

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