Caterpillar (CAT, Financial) has been witnessing a drastic fall in machinery demand from the last quarter of fiscal year 2012. As the global mining industry has been weak for the past few years, it is affecting the capital expenditure of companies like Caterpillar. The company is taking steps to curtail its capital expenditure to the maximum extent possible for keeping its top and bottom line from taking drastic downturns.
A soft outlook on three of the biggest mined commodities – gold, copper and coal –Â has made investments unlikely to rise in the coming few quarters. After these prices peaked last in fiscal year 2011, the S&P GSCI Copper Index and CBOE Gold Index has shown a dip by 60% and 59.2%, respectively. The greatest dip has been in the price of coal which has seen a 71% drop in the Dow Jones Coal Index since 2011.
To ascertain whether this mining industry slump can actually affect Caterpillar’s sales in the long run, we first need to look into two major factors – China’s coal inventory and U.S. green emission norms. Also let’s assess if the company is framing any strategies to overcome the present macroeconomic headwinds.
The innumerable headwinds
China is the world’s largest producer of commodities and the largest producer of coal. The country had shifted its focus primarily from mining to manufacturing in order to enhance their GDP growth, but currently the GDP seems to be facing stagnation issues. Also, until the last quarter, China had a huge inventory of unsold coal of around 100 million tons. According to the National Development and Reform Commission or NRDC – the Chinese macroeconomic firm –Â the shift in the economic approach taken by the Chinese government has caused the accumulation of huge coal stockpile within the country.
Also, as U.S. green emission norms are becoming more stringent, the EIA has forecasted that there will be a likely shift from coal to natural gas in power generation plants where carbon dioxide emission is to be controlled.
Caterpillar’s management also does not have much hope vested on the mining industry revival this year, and thus while posting the second quarter results in July, the top brass have kept the earnings estimate at $6.20 a share for the fiscal year which is below Bloomberg analysts’ expectations of $6.23 per share.
CEO Doug Oberhelman has raised concerns on customers deferring maintenance which might have a detrimental impact on revenue from the mining equipment sales. As prices remain weak, customers are turning into penny-pinchers as there are seldom any coal mine openings or expansions happening round the globe.
Management initiates firm action
As the company’s profits are under immense pressure from the mining sector downtrend and construction equipment sales is also weak with China’s economic progress currently under close watch, Cat’s management is devising a strategy meant to offset the major decline in overseas sales. This new strategy is aimed to steepen up the marketing of remanufactured equipment, mainly in developing markets where entry barriers based on tariff and non-tariff trade exist.
The second quarter of this year has seen a 10% fall in global machinery sales, with the greatest drop from Asia where sales dropped 30% in both May and June. But the company seems focused on beefing up the sagging sales numbers and improving global business revenue by 20% by 2020.
As the remanufactured products carry the same durability, performance, quality and warranty equal to those of a new product, selling them at reasonable prices is the motive of Cat. The major hindrance is the presence of entry barriers for remanufactured equipment for which Cat’s top bosses are talking with policymakers, government regulators and customs officials of several developing countries. They are expecting the developing markets to open up in order to expand remanufacturing options for the company’s customers.
Final note
Cat is aggressive to manage the existing headwinds which are impinging on its sales to a considerable extent. As the company management has devised a solid strategy to meet their sales expectations, it would be best to observe whether the discussions started with the officials of the developing countries finally bear fruit. So let’s stay tuned and keep watching.
