Will This Dead Cat Bounce or Come Back to Life?

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"This year has proven to be difficult..." according to Caterpillar . With earnings down over 40% in the third quarter, that would seem an understatement. Since this year is a bust, the big question is what happens in 2014?

Mining the problems
Caterpillar has invested heavily in the mining industry. The logic behind the choice is sound. Mining equipment is heavily used, thus requiring frequent replacement. And there is a big market for parts, which wear out quickly because of near constant use. This suggests a robust new equipment market and a growing parts business, which provides a relatively stable recurring income stream.

However, Caterpillar's timing hasn't been so good. Over the last year or so the mining industry has been in triage mode. That's why the company's Resource Industries segment, which sells to miners, accounted for 75% of Caterpillar's third quarter shortfall. While other business lines have been weak, too, until the mining industry starts to rebound, performance will likely remain subpar.

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Cutting back
Caterpillar has been cutting back, reducing expenses by $700 million and cutting capital expenditures by some $400 million. This has included trimming its payroll by 13,000 employees over the past year. The company, however, isn't the only one working on cost savings, which is why 2014 isn't likely to see much of an improvement over 2013.

For example, globally diversified miner BHP Billiton is on a cost-cutting spree. In fiscal 2013, which ended in June, the company cut costs by $2.7 billion. For 2014, the company has cut capital expenditures by another 25%. And management is suggesting that 2015 could see further cuts.

Another part of the problem for Caterpillar, however, is that BHP Billiton is also focusing on increasing its productivity. For example, the company has increased its 2014 iron ore guidance by five million tonnes because of the "deployment of mobile crushing units and the continued de-bottlenecking of the supply chain." Although a portion of this increase was the result of an investment in equipment, longer-term productivity improvements reduce the need for new equipment even though the company is pulling more product out of the ground.

Like BHP Billiton, Canada's Teck Resources has been working to cut costs and increase productivity. For example, despite a $330 million cost reduction program, Teck was able to increase its coal production by 6% year over year in the third quarter.

Unfortunately, a 28% decline in price left the top line well off of year-ago levels. Teck's third quarter earnings fell to $0.44 a share from $0.73 the prior year. That's a big drop. And, like BHP Billiton, the company appears to be putting off spending over a longer period of time. For example, Teck is delaying development at one mine "until we see a sustained improvement in demand for steelmaking coal." And that's not the only big project that's been put on hold.

A lingering issue
Neither Teck nor BHP Billiton is likely to ramp up spending on equipment until the mining markets start to improve. Although demand for mined products has remained relatively strong overall, the spending binge during the upcycle has left an overhang of supply and caused a drop in commodity prices across a broad array of commodities.

Until supply and demand come back into balance, capital spending in the mining industry is likely to remain weak. BHP and Teck are just two examples of the cost cutting trend. But the pair highlights the long-term nature of the issue. This means that Caterpillar's mining sales will remain a weak spot.

That said, the capital spending pullback can only last so long. Watch the financial results and spending patterns at big miners like BHP, Teck, and Peabody Energy for a sign of things to come at Caterpillar. Caterpillar's business isn't likely to pick up until after the miners see an uptick, however, so don't expect 2014 to be much better than 2013.  

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The article Will This Dead Cat Bounce or Come Back to Life? originally appeared on Fool.com.

Reuben Brewer has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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