Declining Commodity Prices Drive Caterpillar Downhill
The decline in the price of commodities has put Caterpillar Inc. (CAT), the world’s largest manufacturer of construction and mining equipment, in a rough patch.
The share price declined from $89.62 in May 2015 to $56.36 in January 2016. Since then, the price has recovered marginally to close at $69.09 on Tuesday.
Fundamentally, due to the nature of business exposure, the share price of the company is closely correlated to the price of crude oil and copper. When these two commodities rise, the share price of Caterpillar normally rises, but certainly not by a similar percentage.
Both crude oil and copper seems to have found at least a short-term bottom. However, it may take several weeks, if not months, before the impact of the rise in price shows on the backlog of Caterpillar.
Most of the industries linked to commodities have cut their capital expenditure in a steep manner in the past two years. Thus, a rise in the capital expenditure can be considered as an indication of better things to come.
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The capital expenditure of Caterpillar decreased from $4.5 billion in fiscal 2013 to $3.4 billion in fiscal 2014. However, the capital expenditure decreased marginally to $3.3 billion in fiscal 2015. Thus, it looks as if the construction and mining industry is all set to make a turn around. However, it would take several months before the company experiences a positive impact in its balance sheet.
Caterpillar is currently restructuring its business. By 2018, the company expects to trim down its workforce by 10,000. The number of Caterpillar employees is currently 105,700, down 8% from what it was in 2014. Earlier this week, the company announced that it will stop the production of highway trucks. The process would result in the elimination of around 70 managerial positions.
To achieve better efficiency, the company plans to merge its power and energy divisions by June 2016. The merger will enable the company to streamline the operations and reduce the number of executives by 13%.
During the fiscal 2015, the company’s net income has declined to $2.10 billion or $3.50 per share from a high of $3.69 billion or $5.88 per share in the year-ago corresponding period. The net margin has declined to 4.47% in 2015, from a high of 6.70% in the prior-year similar period.
For fiscal 2016, the company expects a 10% decline in the performance, compared to last year. The company has forecasted revenue between $40 and $44 billion for fiscal 2016. Including restructuring charges, Caterpillar expects earnings of $3.50 per share for fiscal 2016. Thus, fundamentally the share price of the company is not expected to appreciate in the short-term.
Technically, as shown in the image below, the stock faces resistance at 80.50. Support exists at 41 levels.
The declining channel indicates further downtrend in the share price of Caterpillar. Thus, a binary options trader can purchase a put option contract with March end expiry. The suggested strike price for the put option contract is $60.
