This Heavyweight Is Underplaying Its Most Profitable Business
Caterpillar shares have lost 9% year to date as the mining sector, one of the company's key end markets, remains stuck in a rut. But as investors devote most of their attention to its mining business, Caterpillar feels they're missing the bigger picture.
In a recent presentation at Citi 2013 U.S. and European Industrials Conference, Rich Moore, Manager of investor relation at Caterpillar said, "Mining is receiving a disproportionate share of attention." If that's true, and if mining is "just one of" the company's main business segments, as Rich put it, are Cat's other businesses good enough to push the company up the growth trajectory? Let's find out.
Where Cat wants you to focus
If Caterpillar finds mining overrated, it considers its power systems business as the "mostunappreciated group" among all its business segments. Well, Cat may be right on that one.
Caterpillar primarily sells gas engines, turbines, and locomotives through its power systems business. Until last year, the division accounted for about a third of the company's total revenue. The scene has changed dramatically over the past few quarters - Power systems is now Cat's largest business, in terms of sales as well as profits.
Although sales from the business declined 12% and 5% year over year during the first and second quarters, respectively, the division was nevertheless the top performer in both the quarters. More importantly, not many know that power systems is also the biggest contributor to Cat's profits even in these trying times -- The division accounted for a whopping 49% and 61% of the company's total operating profits in the first and second quarters, respectively.
Judging by these numbers, Cat's power systems business may have indeed escaped the market's eye amid the mining crisis. But I think the company itself is partly to blame since it has generally played down the business. I don't remember any big investment into the division since the acquisition of engine maker MWM in 2011. And how many times have you heard Cat start a presentation with a discussion on the power systems business? Small wonder, then, that the public hasn't paid much attention.
What you can't ignore
Looking ahead, Cat's power systems business has huge growth potential, thanks to its diversity -- It serves industries ranging from oil and gas to electric power to railways. But how well Caterpillar capitalizes on the opportunities remains to be seen.
So far, the company hasn't been as aggressive as close competitor General Electric , especially in the oil and gas space, which also happens to be the largestsegment within Cat's power systems business.
For perspective, while GE has spent more than $14 billion on its oil and gas business since 2007, Cat has prioritized its resource industries -- basically, its mining business -- by pumping more than $15 billion into it in the past four years.
While GE's oil and gas business grew at the fastest pace over the years, Cat's mining business has yet to reach the growth levels investors want to see. Furthermore, even outside the oil and gas space, GE is doing tremendously well -- it recently bagged a huge $2.7 billion contract for turbines to power Algeria. Caterpillar hasn't given investors any such reason to celebrate in a long time. .
That said, Cat's power systems business is the most profitable of all - a fact no investor can afford to ignore.
The business that isn't building right
Cat's construction-equipment business has comparatively received greater attention from the market, since Caterpillar is also the world's largest construction-equipment maker. But look inside, and the business seems to be losing its sheen.
At 29% of revenue, the construction industries division contributed the least to Cat's top line last year. Worse yet, it added only 20% to the company's operating profits.
If that sounds uninspiring now, bear in mind that the persistent weakness in key markets like China could only worsen things moving ahead, especially since China tops the list of Cat's target growth markets.
Just last month, smaller construction-equipment play Manitowoc faced a major setback when China-based Shantui called off its joint venture with the company, citing China's weak economic conditions and unfriendly investment policies as the reasons.
Cat's journey into China hasn't been too smooth, either. It suffered losses worth half a billion dollars earlier this year because of accounting misconduct at ERA Mining Machinery, which Cat recently acquired.
The European markets are sluggish, and demand for construction equipment from Brazil and India has also declined in recent months. So even if the North American construction market remains strong, Cat needs a lot more help to breathe some life into its dwindling construction-equipment sales.
The Foolish bottom line
Cat's power systems business certainly deserves more attention than it currently gets. At the same time, investors will not take their eyes off the mining-equipment division. They shouldn't, really, since the mining malaise is also behind Cat's dismal full-year outlook. No matter how well Cat's other businesses perform, its mining side has too much at stake now to expect investors to remain calm.
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The article This Heavyweight Is Underplaying Its Most Profitable Business originally appeared on Fool.com.Fool contributor Neha Chamaria has no position in any stocks mentioned. The Motley Fool owns shares of General Electric Company. 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.