Will Caterpillar Get Slammed for Its Price Rise?


Are you planning on buying a steam shovel or backhoe loader sometime next year? Probably not, but there are many businesses that are, and they'll be forking out more for the equipment sold by Caterpillar (NYSE: CAT) . The company just announced an across-the-board global price hike of up to 3% on most of its products. The stock price slid a little on the news, opening an even bigger opportunity to get one of the better industrials at a discount.

Mining profits
Lately, the very successful Caterpillar has been the victim of high expectations dashed by news that (gasp!) wasn't rosy and positive. At the end of September, citing weakness in commodity prices and weakened demand, it cut its guidance for fiscal 2015 by several dollars. The company now expects to net $12-$18 per share, instead of the previously anticipated $15-$20.

And then it announced the price increases; at the moment it's unclear whether they're included in the revised EPS figures. Shares have dropped about $10 from where they were prior to the revised guidance, and now at $85 or so, they trade more than $30 below their one-year high.

This leaves the company's stock trading at a trailing-12-month P/E below 10, and a forward P/E of less than 8.5. This is a firm that just posted the best quarter in its long history, with a 67% year-over-year net profit jump (to $1.7 billion, or $2.54 a share) and a solid improvement of 22% in revenue. These far exceeded market expectations.

Most impressively, a lot of that boost came from the company's resource industries unit. As its name somewhat implies, much of the division's custom is derived from the sale of mining and quarrying equipment. Given the weak market prices of many commodities at the moment and the perceived dark future of environment-fouling goods like coal, mining isn't a favorite industry at the moment.

Unless you're Caterpillar; the company's 2Q saw a massive 68% year-over-year boost in revenue for the segment, to $5.4 billion.

That means resource industries might, given even modest recovery in commodities, become the key profit center for the big Cat. Of its three main segments (which include construction industries and power systems), resource industries is now a close No. 2 behind power systems, just barely eclipsed by the latter's $5.5 billion in revenue this past quarter. Out of the three, resource industries contributed 32% to the company's overall top line; that figure in 2Q 2011 was only 22%.

A good buy
The year-over-year revenue jump for the segment, although impressive, wasn't entirely organic. A big chunk was courtesy of Bucyrus International, the mining equipment specialist Caterpillar purchased in 2010. Along with the former MWM Holding, a smaller acquisition in the power generation field, Bucyrus was responsible for $1.4 billion in sales during that smashing 2Q, or roughly one-quarter of the resource industries segment's total.

This is doubly impressive. First, it shows how good a buy Bucyrus was and how quickly it's adding to the top line -- the company cost $8.8 billion to acquire, and already it's bringing in billions for Caterpillar. Second, it's proof that resource industries is growing of its own accord; even stripping out the $1.37 that includes the ex-MWM Holding's sales leaves over $4 billion in "original" Cat resource equipment sales. That's a 25% improvement over 2Q 2011.

Caterpillar looks to be on pace to grow those pretty top line numbers. Late last month, it unveiled a new line of mining shovels able to lift a massive 120 short tons of ore, or around the load 50 or so pickup trucks can carry.

That should be attractive to large-scale-mining powerhouses like Vale (NYSE: VALE) , which for instance was scooping around 3,755 tons of nickel from its Creighton mine in Canada every day. Another company that should find such mechanical monsters appealing is Cliffs Natural Resources (NYSE: CLF) , a global miner that, in one small example, extracted around 1,400 tons of coal daily from its now-sold Sonoma mine in Australia.

Canaries in a coal mine?
Caterpillar's acquisition of Bucyrus must have seemed risky at the time; then, as now, no one was predicting a bright future for mining. It's actually a very positive sign for the company that the situation hasn't changed much (in fact, if anything it's been exacerbated by the construction slowdown in China, among other factors). Despite the less-than-ideal conditions, it's managing to convince more customers to buy those wares.

But they'll need to battle for that business. Even though Bucyrus is no longer the competition, feisty rivals are ready to pounce. Joy Global (NYSE: JOY) is one of them, and it's got plenty of fight. The day after the Cat purred about its 120-ton mining shovel, Joy did it one (or fifteen) better by promising a 135-ton product. Meanwhile, the King of Industrials, GE (NYSE: GE) , will be stepping into the market in a big way; it plans to acquire more mining assets and bind them together in a business unit to be known as GE Mining.

The tussle might be over a shrinking patch. According to Joy's CEO, capital spending next year by the Vales and Cliffs of the world is expected to drop 5%-10% in total if commodity prices remain at or around their current gloomy levels. Caterpillar has done well of late in the face of adverse market conditions. Judging by the downward trajectory of its shares, however, investors are skeptical as to whether this winning streak can continue.

Resourceful in resources
Most likely it can. In recent quarters and years, Caterpillar has demonstrated an ability to be nimble in the market, capitalizing on seemingly contrarian opportunities others have missed -- like the Bucyrus acquisition.

Although 2Q might just end up being the positive anomaly in the company's results going forward, it's forging ahead with new products and is poised to continue growing top and bottom lines. Besides, a lot can happen between now and 2015... like a commodity price recovery, for instance. Given all of this potential, nobody should be too spooked by reduced guidance or a modest increase in prices.

We've got plenty more to say about Caterpillar and its prospects, which we think are excellent. Caterpillar is the market share leader in an industry in which size matters, and its quality products, extensive service network, and unparalleled brand strength combine to give it solid competitive advantages. Read all about Caterpillar's strengths and weaknesses in our brand new report. Just click here to access it now.