In the pits
The end of the 10-year commodity super-cycle was never going to be a picnic for companies that supply miners with dump trucks, excavators and other heavy equipment. But Caterpillar’s woes suggest both the industry and analysts are underestimating the severity of the slump.
The sector leader’s shares fell more than 6 percent after it missed consensus earnings estimates for the fourth quarter in a row. Yet Caterpillar and its rivals are still trading at valuation multiples that imply a recovery soon. That’s wrongheaded.
After a decade of digging new pits as fast as they could, big mining companies are locked in austerity mode. Billions of dollars’ worth of projects have been cut or put on ice. Recently installed bosses at BHP Billiton, Rio Tinto and Anglo American have been hacking back capital spending plans to appease shareholders after the excesses of the boom years. Glencore Xstrata Chief Executive Ivan Glasenberg has also been wielding the knife. There are some exceptions – Rio Tinto is pressing ahead with a multi-billion dollar ore expansion in Australia’s Pilbara. But in general miners are focused more on boosting productivity than digging new holes.
The new tendency to buy less and sweat existing assets more has given machinery makers a nasty hangover. Caterpillar said new orders in its resources business, its highest-margin segment, remained “very low,” despite an overall increase in global mining output. Sales of replacement parts, which typically act as an earnings buffer in downturns, also fell short – a trend Caterpillar attributed in part to miners delaying routine maintenance.
Eventually, increased demand for raw materials along with the current dearth of new orders should mean a rebound in equipment demand. But investors already seem to think a recovery is around the corner: shares of Caterpillar and rivals Metso and Joy Global trade between 12 and 14 times forward twelve-month earnings, according to Reuters data. That’s up from 6 to 8 times in the middle of last year.
Such moves might make sense towards the end a typical cyclical blip when earnings are low. Judging by Caterpillar’s latest disappointment, though, and a forecast of basically flat sales next year, the industry looks set to be nursing a severe headache for some time to come.