Wednesday, April 24, 2013

Analysis: Caterpillar cries "uncle" on mining; investors cry "buy"

By James B. Kelleher

CHICAGO (Reuters) - An odd thing happened on Monday when Caterpillar Inc , the world's largest maker of earth-moving equipment, posted disappointing profits and cut its full-year forecast, blaming weakness in the mining industry it bet on so heavily in recent years.

Its shares rallied.

When other big U.S. companies, including General Electric , International Business Machines Corp and Textron Inc , have warned of slowing profit growth in recent days, the news has unnerved investors and sent their stock prices lower.

So what was different about Caterpillar?

Part of the answer, analysts said, was that its announcement was not a surprise. The company has warned repeatedly in recent months that demand from mining customers was deteriorating.

Another factor was Caterpillar's upbeat assessment of the outlook for the construction industry, especially in the United States and China. And a share buyback always helps - this one to the tune of $1 billion in stock this year and as much as $3.8 billion by the end of 2015.

But analysts said the overly bleak assessment Caterpillar provided on Monday for its sales to the global mining industry also, ironically, helped the shares. In a nutshell, no one believes it's really going to be quite as bad as it says, even given the recent slide in gold and copper prices on concerns about weak global growth.

Rob Wertheimer, an analyst at Vertical Research partners, said the new outlook for mining implies a downturn that would put the mining industry demand back near 2009 levels, where it bottomed out in the last downturn.

"We obviously didn't expect that level of collapse in an otherwise mostly recovering global economy," Wertheimer said.

Neither does Caterpillar.

The company is, after all, predicting the world economy is going to grow modestly enough to fuel demand for industrial commodities that miners wrest from the ground using Caterpillar's yellow machines.

"It's not a great economic climate, but it is good enough to keep commodity production going," said Mike DeWalt, Caterpillar's corporate controller.

In fact, Doug Oberhelman, Caterpillar's chief executive and chairman, said on Monday the current drop-off in mining orders was as much a function of the changing focus of its mining customers as it was a function of concerns about global growth.

"There has been quite a bit of management change with some of our big customers and...the new management is much more focused on operating costs, short-term cash flow, sweating their assets a bit," Oberhelman said during a conference call with analysts.

Caterpillar's sales to the mining industry are more profitable than sales to construction and industrial customers.

The fatter margins were one of the reasons it made mining equipment a focus of its M&A activity in recent years, buying Bucyrus, a U.S. maker of giant excavators and shovels, for $7.6 billion in 2010 and - more notoriously - ERA Mining, a Chinese mining equipment company, for $654 million.

In January, Caterpillar said it was writing off three-quarters of the money it paid for ERA after uncovering "deliberate, multi-year, coordinated accounting misconduct" at a subsidiary of the Chinese firm.

The ERA debacle was, in the minds of many analysts, a symbol of a rash rush to double down on the notoriously cyclical business.

But even before ERA blew up, the company's exposure to the resource industry was being questioned as many of its key mining customers, facing investor backlash over unpopular takeovers, budget overruns and falling metal prices, slashed capital spending, slowed development on some projects, shelved others entirely and postponed -- or canceled new equipment orders.

Caterpillar, however, continued to hold out hope that mining orders, which began to fall during the second half of 2012, would improve as 2013 unfolded. The market was skeptical - and sent Caterpillar's shares down as much as 30 percent from the 52-week high of $108.79 they touched last spring - as it waited to see if the trickle of bad news on the mining front became a torrent.

On Monday, Caterpillar essentially gave up on mining for 2013, saying it now expects sales of traditional mining machines -- large trucks, large loaders, large bulldozers and the like -- to be down 50 percent from 2012, and the excavators and shovels made by its Bucyrus unit to be down 15 percent.

And that was just what the market was waiting for, analysts said.

"The cat's out of the bag," said Larry De Maria at William Blair & Co. "With Monday's report and conference call, Caterpillar confirmed what bears have been warning about: mining will drag down EPS."

Adam Fleck, an analyst at Morningstar agreed.

Fleck said Caterpillar decision to throw in the towel on mining sales for 2013 gave investors confidence the company was no longer in denial.

"Investors knew it would be bad, but wanted some quantification from the company," he said.

And it was that capitulation, ironically, that made Caterpillar one of the S&P's biggest gainers on the day.

(Reporting by James B. Kelleher; Editing by Leslie Gevirtz)

Source: http://news.yahoo.com/analysis-caterpillar-cries-uncle-mining-investors-cry-buy-013234098--sector.html

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