Caterpillar lays off close to 24,000 workers

It was less than a year ago that warp-speed growth in the mining and construction industries was causing industry-wide shortages of everything from ore-hauling trucks to tires.

Mining companies like Barrick Gold (ABX-T, ABX-n) were scrambling to find more creative ways of securing critical equipment. The Canadian gold major even agreed to loan Yokohama Rubber of Japan US$35 million so that the Asian tire maker could build a second production line and in return provide Barrick with a secure supply of off-the-road tires for a ten-year period starting in 2009.

The landscape is very different today and few events illustrate the depth of the slowdown as well as the massive layoffs taking place at Caterpillar Inc. (CAT-n), the world’s largest maker of mining and construction machinery.

Since late last year, the Peoria, Illinois-based Caterpillar has said it will lay-off about 24,000 workers and isn’t ruling out more cuts in the coming months.

Crashing commodity prices, tight credit and abysmally low housing starts sent Caterpillar’s fourth-quarter profit tumbling 32%. Earnings came in at US$661 million, or $1.08 per share, down from $975 million, or $1.50 per share, a year earlier. (The $1.08 per share includes a one-time benefit of 67 cents per share from a tax credit of $409 million in the fourth quarter.) Revenue rose 6% to $12.92 billion.

“Through the first three quarters we experienced booming demand from key global industries, notably mining and energy, and most emerging market countries,” Jim Owens, Caterpillar’s chief executive, said in a statement announcing the company’s fourth quarter results on Jan. 26.

 

“Then we were whipsawed in the fourth quarter as key industries were hit by a rapidly deteriorating global economy and plunging commodity prices. In anticipation of lower demand we encouraged dealers to align inventory with declining volume, and they responded with significant order cancellations, particularly in December.”

Caterpillar expects 2009 sales and revenues to be in a range of “plus or minus 10%” from $40 billion. If sales and revenues reach $40 billion, the company expects to achieve a profit of $2.50 per share, excluding redundancy costs. (Caterpillar estimates those redundancy costs are US$500 million, or 56 cents per share, with the bulk in the first quarter.)

James Dugan, Caterpillar’s head of corporate affairs, declined to return phone calls or e-mails from The Northern Miner requesting comment.

Alexander Blanton, an analyst at Ingalls and Snyder, an independent management investment firm in New York, who has followed the Caterpillar story since 1973, believes that there is a good chance the company’s profit per share will be less than Caterpillar’s $2.50 per share estimate. He forecasts a profit per share of $2 excluding redundancy costs, and believes the equipment maker will suffer a loss in the first quarter including redundancy costs.

“The problem is nobody can forecast in this environment,” he said. “We don’t know how long the recession will last and even if we did it would be hard to forecast, so now it’s impossible.”

At press-time Caterpillar’s shares were trading at about US$26.86 apiece, down from their 52-week peak of $85.96 per share on May 19 2008. (The company has 603 million shares outstanding.)
“We see the share price is basically going to range bound in this market,” said Kristine Kubacki, a research analyst covering Caterpillar at Avondale Partners in Creve Coeur, Missouri. “The last bastion of health for the company had been the mining group but we have seen the downturn in the commodities markets and the capex numbers have been pulled in.”

Machinery makes up about 67% of Caterpillar’s total sales, according to the company’s 2007 annual report, and of its total machinery sales, mining equipment makes up about 22%.

Apart from U.S. President Barack Obama’s US$787-billion stimulus package, “there hasn’t been a lot on the horizon in terms of good news for the industrial group in general,” Kubacki added. “What is the catalyst for Caterpillar to move higher?”

Still, Kubacki said she was comfortable with her 52-week target price on the stock of US$33 per share: “I have to believe the major down draft in the stock has already been felt.”

Blanton of Ingalls & Snyder doesn’t have a target price but noted that at a price of $27 per share, Caterpillar’s dividend was still $1.68 or a 6.2% yield or a 5.3% yield after tax, an amount he described as “pretty good.”

“That’s a heck of a lot better than you can get in a money market fund,” he said. “It’s a very good after-tax yield so that limits the downside as long as they can maintain the dividend and I think under any reasonable set of circumstances – even in the worst case scenario – they can do that because they have good cash flow even at low levels of earnings.”

Blanton added that typically in bear markets valuations become “meaningless for the most part” or at least much less meaningful than they are in bull markets. “Earnings levels don’t mean much because people don’t have confidence that they will continue so people don’t assign much credibility to them,” he explained.

As the dominant company in its business worldwide with a “fantastic” customer franchise and dealer organization, Blanton argued Caterpillar remains in a reasonably strong position. But he conceded that if the bear market continues the stock could go down some more “but not into the single digits.”

When you don’t have visibility and when you can’t rely on earnings stocks can slip much lower than you might think, he added, and that can be accentuated by forced selling by hedge funds and other kinds of funds.

“What happens at the end of a bear market is that the strongest stocks finally sell down because there’s nothing left to sell at a decent level,” he said. “So some of the best stocks are hit at the end from redemptions and margin calls because that’s when people get desperate to raise cash.”

Blanton said he expects there are bound to be some reductions in prices for mining equipment but they won’t be big. If steel prices fall further, he added, the company will likely pass on those savings to consumers.

Jeffrey Christian, managing director at New York City-based commodity consultancy CPM Group, said the reductions are already being felt. “We are already seeing both a reduction, relatively slight right now, in mining equipment costs, and a larger easing of supply constraints and delays in mining operations’ ability to secure equipment.”

The good news is that when the bottom is finally reached, Caterpillar will be “a big beneficiary of the next up-cycle” Blanton maintained. And he said that Caterpillar is in a much stronger position today to weather the economic downturn than it was during the 1980s recession.

Not only does it have better product differentiation and a stronger consumer franchise than it did twenty-five years ago, he explained, but Caterpillar’s plants are far more efficient and have moved from a system of batch processing in which it took as long as three months to produce a simple machine part, to a lean, world-class processing system in which the same part can be produced in a single day.

Caterpillar has also diversified significantly since the last big downturn and have a greater number of services that are perhaps not as economically sensitive such as logistics and remanufacturing, or taking equipment back and refurbishing it. In short, the company has a much broader product line that is not as cyclical as it used to be.
“They are in far better shape than they were in those days,” he concluded. “The economy is worse off than it has been since the 1930s but their business is stronger than it was 25 years ago.”

Kubacki of Avondale Partners noted that Caterpillar’s inventories “seem appropriate in the mining sector” and that new equipment in general at the dealer level seems like it is at a “decent” level.
“There has been such a backlog of mining equipment in the past few years and the backlog was comfortably three or four years out,” she said. “Now the spigot has been turned off and it will be interesting to see what happens.”