A few days back, at the CNBC/Institutional Investor Delivering Alpha conference, legendary short seller Jim Chanos said that shorting Caterpillar Inc. (NYSE:CAT) was his best investment idea of 2013. His short thesis was based on the fact that the company is facing “commodities super-cycle headwinds.”
Caterpillar Inc. (NYSE:CAT)’s recent results proved that Jim Chanos was right. The company lowered its global growth outlook. Sales declined across all equipment segments with mining being the worst performer. In addition to slowing end markets, the company is also seeing significant inventory reduction at dealer level.
Although the company is expecting the second half of this year to be better than the first, there is little evidence on ground level that suggest that things will improve in the near to medium term. The company’s backlog declined to $19.1 billion from $20.4 billion sequentially, and the visibility going into the back half remains poor.
I believe the trend of lowering guidance has just begun, and the company might continue to reset Street expectations lower in the coming quarters. Although the company is trading at just 12.83 times the mid point of its current year EPS guidance, one needs to understand that the company is near the cyclical peak and its EPS is likely to decline going forward.
Caterpillar Inc. (NYSE:CAT) posted and EPS of $8.90 in 2012 and is expected to post an EPS of $6.84 in 2013 according to sell side estimates. Its revenue is expected to decline 10.90% in 2013. If we look at consensus estimates, the sell side is expecting revenue and earnings growth in the next year, but there is a little evidence that suggests that they might be right. I believe mining capex is unlikely to accelerate thanks to the Chinese slowdown and price headwinds commodities are facing.
In the last year and a half, Caterpillar Inc. (NYSE:CAT)’s sock price has corrected ~25%. I believe this downward trend is likely to continue going forward, and, hence, I recommend a sell on the stock.
But this story doesn’t end with Caterpillar Inc. (NYSE:CAT). Other equipment manufacturers are facing similar headwinds. The most notable among them is Joy Global Inc. (NYSE:JOY). Joy caters solely to the needs of the mining industry, which is the weakest end market, even for Caterpillar Inc. (NYSE:CAT). Joy Global Inc. (NYSE:JOY)’s stock declined ~50% in the last two years.
Although the company’s management is taking right steps in terms of using cash flows to repurchase shares and make accretive acquisitions, the macro headwinds keeps me on the sidelines. There has been an excess capacity in the mining industry thanks to a decade long bull run in commodities. It will take at least a few more years and the shut down of more mines before supply/demand condition reach an equilibrium level again.