Economical Analysis of Caterpillar Inc

This report will look into the use of micro and macro-economic by business management to determine business performance, future forecasts and investment decisions. Section 1 will consider management of a UK-manufacturing business, determining that the use of microeconomics will lead to the consideration and macro fundamentals. To provide relevant examples, section 2&3 will consider management of Caterpillar Inc., a global manufacturer of construction and mining machinery.
Section 1 – Micro/Macro Economics
This question will look into the factors under consideration by management in the UK, taking both a micro and macro-economic view. From a micro-perspective, management may look into the buying behavior of the biggest customers for their goods, (Boyes, 2012). Microeconomics considers the behaviour of individual consumers and businesses to understand the decision-making process; given this, management can use microeconomics to determine the buying behavior of their major customers. This may help management identify determinants that affect their customers buying behaviour such as economic fundamentals, which could then be used to build forecasts (Kreps, 2004). To support analyses, management could also consider macroeconomics and the wider economic outlook, given that the outlook and confidence in the economy will impact on individual business confidence. To provide an example, the study of micro-economics may then lead into a more macro view; if management determines that buying from local customers is depressed they may then consider the performance of the UK economy to determine why customers buying are lower than expected.

Looking into macroeconomics, a business may look into variables such as GDP growth, inflation, employment and purchasing managers index (PMI) to gauge a view on the performance of the economy, (Arnold, 2010). For example, if the economy was performing better than expected, the business may be willing to increase production and build up stockpiles in anticipation of increased buying in the future. On the other hand, if the business considers economic fundamentals to be weak, they may decide to cut production early to reduce stockpiles (Singh, 2013) [Online].
If the company sells products internationally, then management should also consider international economic performance and exchange rates in order to gauge both international demand and prices received in the home currency. International performance may also help determine decisions in terms of future investment, if the company is developed in its home market. For example, a manufacturer of car-parts may consider forecasted exchange movements and economic conditions (e.g. future demand for cars) to determine future direction of investment (Miller, 2013).
Section 2 – Economic Theory
Focusing on a microeconomic perspective, management may consider sediment from customers to determine future forecasts for the market. For example this question will consider the role of management will in a real-world company. Take mining-services companies such as Caterpillar Inc., and Joy Global Inc. To gauge demand these companies may look into forecasts from major miners and so major customers such as Rio Tinto, BHP Billiton and Glencore-Xstrata (PWC, 2013). If these miners are bearish on market performance and demand for their commodities, then services companies such as Joy may take a bearish stance in anticipation of weaker demand in the future, (McDonald, 2013) [Online]. For example, over the economic downturn, sales to mining companies fell drastically as low commodity prices forced major miners to cut costs to remain profitable. This is important as the business demand from a certain area may be dominated by a few; for example take Caterpillar. If the business has an operation in Perth, Australia, it is more than likely that demand would be subject to iron ore production, which is dominated by majors such as BHP Billiton and Rio Tinto. With this, Caterpillar would play close attention to these companies; there competitiveness, demand for their products, future capital expenditure plans etc.
Management of Joy and Caterpillar both reacted by cutting capacity as sediment from miners continually weakened over the years; yet company presentations and reports from both companies contained quotes and reference to major miners, underscoring the importance of sediment (forecast and opinions) from customers. Using these variables would help management forecast future demand, which could then be used to build forecasts for the future performance of the company.
Taking macroeconomic factors, companies such as Caterpillar Inc., would focus on economic variables in a bid to forecast future economic conditions. For example, Caterpillar’s two major markets are mining and construction machinery/ services. Given this, the business may focus attention onto Chinese macro-variables such as GDP Growth, Investment Growth and PMI to determine future production growth, which would then impact on construction and heavy-industry demand. This would then support demand for commodities and thus demand from Caterpillar’s mining customers. Given the scale and time-frame of some investments, businesses will need to construct long-term forecast models to calculate return on investment and the underlying demand in a market.
By focusing on these variables, the company should be better equipped to forecast demand for their products and so tailor their production to meet market conditions.
Section 3 – International Expansion
To answer this question, the management at Caterpillar will be considered investing in a non-EU market, taking Peru as the example. Peru has been chosen because of its buoyant economic conditions and booming mining industry, supported by the country’s wealth of minerals, most notably copper (KPMG, 2014).
Furthermore, the booming mining industry has supported economic development, thus supporting the construction industry and need for infrastructure development. Given this, demand for Caterpillar’s goods should remain resilient, which could support a greater investment into the country. Additionally, surrounding Latin American economies such as Argentina, Chile and Brazil remain strong, which could create further demand for production from the Peruvian operations.
In terms of Caterpillar, one area of interest will be the mining industry. Currently, Peru is the second largest producer of copper, behind neighbour Chile, as well as the second largest producer of silver and sixth largest producer of gold. Over the past few years, investment has poured into the sector, as a number of major copper projects were announced to feed growing demand from China. According to the Peruvian Mines and Energy Ministry, copper production in 2013 is forecast at 1.57mt, representing an 18% increase over 2012, which stemmed from a 7.8% increase in 2011 (Huamani, 2014), while the current value of mining investments in the country tops $10Billion, led by major miners BHP Billiton and Rio Tinto. Since investment activity in Peru has been the major driving force behind the private sector development, the Peruvian government has become more welcoming of business, which should benefit expansion plans by Caterpillar (Ernst & Young, 2014).
Table 1 below displays a number of key economic indicators for Peru (IMF, 2013)
Table 1 – Key Economic Indicators – Obtained from IMF (2013)
Caterpillar should also consider the stability and availability of the local currency. The national currency is the Peruvian Sol, which has remained relatively stable versus the U.S Dollar over the years (Bloomberg, 2014) [Online].
Caterpillar could also complete a SWOT analysis to determine the potential benefits/ risks behind an investment.
Strengths
Strong real GDP growth and the introduction of tax reforms have strengthened the public accounts, with the country’s relatively strong fiscal position expected to provide support for the economy in the long term.
Peru’s investment grade status should keep foreign investment flows anchored over the long term.
Weaknesses
Peru’s heavy reliance on commodity exports will weigh on the country’s trade dynamics in the next few years, as a hard landing for China’s economy has the potential to dampen both demand and prices for key commodities such as copper.
Underdeveloped infrastructure, capacity constraints, declines in major mining firms’ capital expenditure programmes, and continued social unrest could weigh on output levels over the medium term. This would then impact on demand for mining equipment from the likes of Caterpillar.
Opportunities
Another wave of privatisation schemes for several state-run companies across various sectors could help to deepen financial markets and ease the mining bias of the country’s equity market, (OECD, 2013)
A growing middle class will make consumer-related sectors such as retail food and drink increasingly attractive for investors over the medium-to-long term. This should then support urbanisation in the country, which in turn will support construction projects and demand for machinery, (BBVA, 2014)
Threats
Social divisions within Peru threaten the economy in a variety of ways. A continued intensification of strike action could impact growth and mining output, while heightened unrest and an opposition-dominated congress could pressure the administration into substantial spending increases, weighing on the country’s fiscal position, (OECD, 2013)
The end of Peru’s export boom in light of a weakened global demand has the potential to expose the country’s structural imbalances and dampen investment into vital infrastructure.
Caterpillar would also consider government policy and attitudes towards spending and regulation. In terms of regulation, Peru has continued to simply legislation to attract more investment, with KPMG (2013: 21) saying “Foreign investors may set up any business enterprise in Peru without limitation and engage in any kind of business”. Furthermore the business would consider the corporate tax rate, which currently stands at 30% (KPMG, 2013). Additionally, in terms of government revenue, Table 1 shows that as government expenditure as a proportion of GDP continues to rise over the forecasted period, government net debt falls, suggesting increasing government revenues and a more stable fiscal outlook. The outlook for monetary policy may also be considered, with current sediment suggesting that Peru’s central bank will hold its benchmark policy rate at 4%, as the country looks to push down its inflation rate. Given this, it is expected that policymakers will continue to stimulate growth in the economy through government spending and also further reductions in reserve requirements for commercial banks, which should stimulate growth and support demand for Caterpillar’s construction machinery.
Caterpillar may also consider demand in neighboring countries such as Brazil and Chile, which like Peru are seeing mining investment to drive production, (Scotiabank, 2014). This provides the opportunity for the investment in Peruvian operations to be seen by the company as a Latin American investment, supplying goods for export to nearby demand centres. This could be supported in Peru given the country has a number of free-trade agreements in place with Brazil, Chile, USA, China, South Korea.
To conclude, Caterpillar will take into account a wide-breath of economic indicators to determine confidence in future forecasts. While the outlook does look positive, headwinds will remain, with growth in Peru determined greatly by demand for its commodities, and thus focused primarily on China. However, a strong pipeline of mining projects and also buoyant infrastructure spending should support an underlying demand for Caterpillar’s equipment which should warrant investment in the country.
References
Arnold, R (2010): Macroeconomics, USA, South Western.
BBVA (2014): Peru Economic Outlook: First Quarter 2014, UK, BBVA Research.
Bloomberg (2014) [Online]: USD-PEN Exchange Rate, Available at http://www.bloomberg.com/quote/USDPEN:CUR, Accessed 01/04/2014.
Boyes, W and Melvin, M (2012): Microeconomics, USA, South Western.
Ernst & Young (2014): Peru’s mining & metals investment guide, London, Ernst & Young.
Huamani, G (2014): Mining in Peru; March 2014, Peru, Ministry on Energy and Mining.
IMF (2013): Data and Statistics Workbook; October 2013, USA, IMF.
KPMG (2013): Investment in Peru, UK, KPMG.
KPMG (2014): Country Mining Guide; Peru, UK, KPMG.
Kreps, D (2004): Microeconomics for Managers, New York, WW Norton & Company.
McDonald, M (2013) [Online]: Weak Mining sector makes Caterpillar cut forecast, Available at http://www.miningaustralia.com.au/news/weak-mining-sector-makes-caterpillar-cut-2013-prof, Accessed 03/04/2014.
Miller, K (2013): A Framework for Integrated Risk Management in International Business, Journal of International Business Studies, 23 (2), pg311-332.
OECD (2013): Latin America Economic Outlook 2014, USA, OECD Research.
PWC (2013): Mine 2013; A confidence crisis, London, PWC.
Singh, S (2013) [Online]: Caterpillar cuts forecasts on decline in sales to mining, Available at http://www.bloomberg.com/news/2013-04-22/caterpillar-profit-misses-analysts-estimates-on-mining-slowdown.html, Accessed 03/04/2014.
Scotiabank (2014): Latin America; Regional Outlook, USA, Scotiabank Research.