Caterpillar In For A Tumultuous Year

BMI View : Despite Caterpillar posting record revenues and profits in 201 2 , the poor performance witnessed in Q412 gives an insight into the potential challenges the company could face going forward . Caterpillar is anticipating a tough year ahead ; however, we believe its outlook is still too optimistic, especially in regards to China and prices for industrial metals. Consequently, we expect the company to perform towards the lower end of its broad profit forecast range.

Caterpillar registered record sales and revenues of US$65.88bn in 2012 - up 10% from that seen in 2011. Profit also reached a record - up 15% to US$5.68bn, equal to US$8.48 per share. However, its Q4 12 was weak, with profit down 55% as the mining sector outlook deteriorated. For 2013, Caterpillar has posted a broad range for its top and bottom line forecasts, reflecting the uncertain mixed outlook facing the company's various segments. Sales and revenues are expected to reach between US$60bn and US$68bn, whilst profit per share is forecast at US$7 - 9.

Caterpillar is anticipated to experience a challenging 2013 , and we expect results toward the lower end of the estimate , based on our current outlook for the mining and construction sectors . The company is facing a supply glut and weak demand in some of its core business units. Its response, a strategy of inventory reduction, will create short term pain for the company, but is an important structural target to increase overall efficiencies over the longer term.

Looking More Cautious Into 2013
2012 Sales And Revenues By Geography (LHS) And Segment (RHS), US$mn

All Sinking Together

Caterpillar's woes are not unique. The building machinery sector was struggling in late 2012, under the weight of falling demand, especially in Asia. This coincides with falling capital expenditure (capex) plans by the big mining companies, who are pulling new investment in response to lower prices and weaker demand. Disappointing results have also been released from competitors Hitachi Construction Machinery, Komatsu and Sany Heavy Industries;. All of them have moderated their outlook for 2013, highlighting weakness in Asia in particular. Indonesia continues to crop up as an area of weak growth, as coal mining activity has declined due to higher cost of production and lower coal prices, whilst China's longer-term capital investment deceleration continues to bite.

All In It Together
Selected Construction Machinery Companies, October-December Revenues

Asia accounts for 27% of Caterpillar's sales and revenues, and we believe this region will present the biggest challenge over 2013. Caterpillar has significantly increased its exposure to China, and while it has stated it is playing the long game there, we are concerned that it has over-exposed itself to the region, which is now struggling to generate demand. However, construction growth in Indonesia could provide support, and we expect Japan and the Philippines to see an acceleration in industry growth.

In the US, we see a mixed picture; demand for construction industries are anticipated to grow, whilst resource industries and power systems will see flat growth. Elsewhere, Europe will remain the weakest market, whilst Middle East,Africa and Latin America should all experience growth.

Painful Short Term Measures

To deal with the glut of construction machinery created by falling demand, Caterpillar has embarked on an inventory reduction programme. The strategy is aimed at rebalancing end-user demand with dealer order rates. In Q412, the company successfully reduced inventory levels by US$2bn, and this was a major factor behind weaker profits for the quarter (down 55% year-on-year [y-o-y] in Q412). The programme is expected to see profit in Q113.

Mining Sector Weakness

Our overall outlook for the global mining sector is less optimistic than Caterpillar's. Where the company is betting on an increase in industrial metals prices in 2013, we expect prices to average lower. This is based primarily on our below-consensus outlook for Chinese growth and thus demand, impacting mining activity globally. This, combined with high costs on mining projects and increased environmental and political risk, is guiding our expectation for weaker mining activity going forward.

Weighing On Demand
Industrial Metals Prices

Asian Market Loses Its Shine

Caterpillar has placed a lot of emphasis on building up its exposure to China, with new and expanding manufacturing facilities being developed in the country. However, with Chinese growth now appearing to be on a weaker trajectory, we believe the company has over-extended itself compared to current demand. Falling sales in China contributed to a 3% decline in sales and revenues in the Asia Pacific region, marking the first y-o-y contraction in that market since Q409. However, Caterpillar claims to be playing the long game in China, and is aimming to establish and consolidate its market share. Despite our expectations that construction sector growth will be much weaker over the next five years than the previous (5.8% on average per annum between 2013 and 2017, versus 11.3% between 2008 and 2012), the industry is the largest globally in value added terms, and will continue to present opportunities.

China And Indonesia Trend Reversal
Asia Pacific Quarterly Sales Growth, y-o-y

Over the short term, Indonesia is also likely to pose concerns on the mining side. The country has been one of the fastest growing markets for building machinery demand, as mining activity has been ramped up. Caterpillar is in the process of developing a new mining truck facility in Indonesia. However, we expect the sector to decline in 2013 - a view that is supported by Caterpillar's major competitors. Hitachi is forecasting that sales of excavators in Indonesia will fall 23% over the year, whilst Komatsu has downgraded its FY2013 (12 months ended March 31 2013) profit and sales expectations, largely due to its Indonesian performance.

Despite this, we believe Indonesia should hold up well on the construction side, with continued strong growth expected. We also expect stronger growth out of Japan for construction, as a focus on infrastructure investment is pursued by the prime minister.

Asian Construction Demand Remains Buoyant
Construction Industry Value, US$bn

North America Mixed Outlook

Our view that 2012 would be the year the US construction sector would return to growth, driven by a revival in residential construction, has played out and was reflected in Caterpillar's performance. In an effort to capitalise on the revival in a sector that has been in decline for seven years, Caterpillar has been investing heavily into expanding manufacturing facilities domestically as well as improving distribution chains.

Construction Will Prove Supportive
US: Coal Production And Construction Industry Value Growth

Conversely, the US mining sector is looking less buoyant, following years of strong growth. The main weakness is the coal market, as cheap natural gas supply in the US is decimating demand for coal. Consequently, production of coal has been falling, and this is impacting demand for new mining equipment. We see this trend continuing over the short term, meaning that the US will remain a mixed market.

Caterpillar Expansion And Investment, November 2011 to January 2013
Date Location Details Product Size Cost Status
Source: Caterpillar
07/11/2011 California, United States Parts distribution centre, Tejon Ranch Commerce Centre na 400,000 sq ft na Completed Q4 2012
11/11/2011 Indonesia Manufacturing facility, Indonesia Mining trucks na na Planned
11/11/2011 United States Expansion of manufacturing facility Mining trucks na na Planned
11/11/2011 United States New manufacturing facility Small track-type tractors and mini-hydraulic excavators na na Planned
16/11/2011 North Carolina, United States Manufacturing facility, Winston-Salem Axle assemblies for largest Cat mining trucks 850,000 sq ft na Opened
30/11/2011 India, (Site selection underway) Manufacturing facility, India Perkins 4000 series engines na US$150mn Planned
30/11/2011 Chennai, India Expansion of manufacturing facility, Chennai off-highway trucks na US$62mn Planned
04/01/2012 Jiangsu Province, China Expansion of research and development centre, Wuxi na na na Planned
17/02/2012 Georgia, United States Manufacturing facility, Athens Track-type tractors, mini-hydraulic excavators 1mn sq ft US$200mn Planned
14/03/2012 South Carolina, US Expansion of manufacturing facility, Sumter Large and small hydraulic cylinders 170,000 sq ft (additional) US$20mn Completed Q4 2012
21/03/2012 Jiangsu Province, China Expansion of manufacturing facility, Xuzhou Hydraulic excavators, wheeled excavators na na To be completed 2016
22/03/2012 Shandong Province, China Expansion of Shandong Engineering Machinery Wheel loaders, motor graders, paving products, SEM track type tractors na na To be completed 2014
30/03/2012 San Luis Potosi, Mexico Parts distribution centre, San Luis Potosi na 500,000 sq ft na To be completed mid-2013
23/08/2012 Texas, United States Manufacturing facility, Victoria Hydraulic excavators 1.1mn sq ft US$200mn Opened
24/08/2012 Queensland, Australia Parts distribution centre, Yatala na 500,000 sq ft na Planned, to be completed mid-2013
09/01/2013 Jiangsu Province, China Manufacuring facility, Tongzhou Proving ground and large wheel loader (Cat 986) na na Opened
This article is tagged to:
Sector: Infrastructure
Geography: Global, China, Indonesia, United States

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