Caterpillar Keeps on Cutting

Caterpillar Keeps on Cutting

The mining industry moved too far too fast on elevated Chinese demand. Now, miners are pulling back—that's left equipment makers like Caterpillar with little choice but to follow suit. However, as the excesses are cleaned up, the foundation of a rebound is being built.

Used equipment
Coal miner Cloud Peak Energy has managed to remain profitable while most of its competitors have been bleeding red ink. The company's well situated mines in the ultra-cheap Powder River Basin are one big help. But so are the company's cost control efforts.

For example, the miner reduced its capital expenditure budget by over 35% this year. Cloud Peak managed this by doing some of the obvious things, like delaying projects. But it has also been extending the life of its equipment and buying used instead of new. Caterpillar noted this industrywide trend, citing lower aftermarket part sales due to companies "delaying maintenance and rebuild activities."

While Cloud Peak's money saving efforts have been music to shareholders' ears, Caterpillar certainly doesn't like the sound of what it's hearing. In fact, Caterpillar just announced plans to shutter yet another factory—this one in Kilgore, Texas. The work will be split between plants in Kansas and Wisconsin with about 100 employees being let go.

That's on top of Caterpillar's already aggressive cost-saving moves, which includes a headcount reduction of over 7,600 full-time employees. However, if the company wants to remain profitable, it has little choice since customers aren't buying like they used to. Revenues were down about 17% in the third quarter with most of the pain coming from the mining segment.

Better, but not good enough
As Caterpillar looks out to 2014, it expects global economic growth to tick up slightly. However, it doesn't believe that will translate into increased mining sales, calling for another "decline in Resource Industries' sales." That should keep a lid on the top line.

Look for the heavy machinery maker to keep on cutting. However, every expense that Caterpillar reexamines is one that helps to set up a rebound. And mining companies haven't stopped all new projects, they are just being more selective in what projects they let move forward. For example, while Cloud Peak is talking about reducing production, relatively tiny Rhino Resource Partners is still building a new mining complex.

Cloud Peak is considering cutting production by 10 million tons at its Cordero Rojo mine in 2015 if markets don't pick up and shifting equipment to other mines to help keep companywide costs down. Rhino, which has also been pulling back in some areas, is still moving ahead with its Pennyrile mine, which won't open until the middle of next year.

Why keep spending? The mine is located in the Illinois coal basin, which is seeing increased demand as customers switch out of other, higher-cost coal regions. The mine is located on a river that gives easy access to a number of customers and export terminals. And, perhaps most important, Rhino already has enough committed sales to justify the spending.

Right sizing
The divergent moves by Cloud Peak and Rhino speak volumes about at least one of Caterpillar's end markets. Essentially, the coal industry is working through a supply/demand imbalance that will leave the best mines standing and less desirable ones closed. This trend is taking place throughout much of the mining industry.

Although difficult to live through for miners like Cloud Peak and Rhino, it is even harder on suppliers like Caterpillar and Joy Global. That said, once mining industries start to work through this rough patch, global growth will again lead to increased demand for mining equipment. Just don't get your hopes up for that to happen in 2014.

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Reuben Brewer has a position in Rhino Resource Partners. 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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