Trouble for mining equipment makers just begun

CHICAGO Thu Feb 5, 2009 8:12am GMT

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CHICAGO (Reuters) - Companies that supply heavy equipment to the mining and energy industry are slashing production, slashing jobs and slashing forecasts as weak metal and energy prices put the brakes on new machine orders.

But with demand deteriorating faster than the companies can react, are they slashing deep enough and fast enough?

The question gained fresh urgency on Wednesday, when BHP Billiton Ltd/Plc (BHP.AX)(BLT.L), the world's biggest miner, predicted mining industry capital spending, on a tear since 2002, would tumble more than 45 percent in 2009 and another 16 percent in 2010.

With copper, iron ore, aluminium, nickel, coal, lead, zinc and oil and gas prices well off the highs they fetched as recently as last summer, BHP predicted the world's miners would spend just $62 billion (43 billion pounds) on exploration and new investment this year and just $52 billion in 2010, down from $116 billion in 2008.

"That's pretty severe," Longbow Research analyst Paul Bodnar said of the projected capex cuts. "But the economics for the small and medium-sized miners have changed significantly."

EVERYBODY HURTS

It's not just the smaller mining and energy companies that are hurting. BHP is widely expected to post its first profit decline in a decade this year.

And several of BHP's chief rivals, including Rio Tinto (RIO.AX)(RIO.L) and Oz Minerals, are heavily indebted and more interested in selling assets than investing in them.

"Momentum and risk in our view is still probably to the downside," BHP Chief Executive Marius Kloppers told analysts. "The turning point for any eventual recovery continues to be pushed out."

It all adds up to an uncertain outlook for the companies like Caterpillar Inc (CAT.N), Joy Global Inc JOYG.O, Terex Corp (TEX.N) and Bucyrus International Inc BUCY.O which provide the industry with the drilling equipment, excavators, trucks, turbines and draglines the industry uses to wrest its riches from the earth.

"As commodity prices go, so goes mining activity," said Matt Collins, an analyst at Edward Jones who covers Caterpillar.

"You can expect Cat's mining business to go right along with that. To the extent commodity prices remain depressed, I don't expect a recovery."

AGGRESSIVE ACTIONS

How bad will it get? Investors will have a better sense of that in the coming weeks as Terex, Bucyrus and Joy Global all report earnings.

The preliminary signs from Caterpillar, the world's largest maker of construction and mining equipment, and rival Terex, are not reassuring.

Early last week, Caterpillar reported disappointing profits, warned of tough times ahead and cut nearly 20,000 jobs citing, among other things, a sudden deceleration in demand from mining and energy customers that had "whipsawed" the company, in the words of Chief Executive Jim Owens.

The company characterized the job cuts, the biggest since the early 1980s when Caterpillar was losing $1 million a day, as its "trough" plan. But then four days later, Caterpillar announced an additional 2,100 layoffs, all at factories making mining equipment, suggesting the company was scrambling to keep up with a fast-deteriorating situation.

Then this week, Terex warned its 2008 earnings, due out next week, would be lower than expected, partly because of reduced production levels.

Although the company did not say which plants it might be closing or idling temporarily, or how many workers it might cut, it said the "rapid change" in end markets was forcing it to take "aggressive actions to reduce costs and inventories in all of our businesses."

In an effort to avoid building up inventory that was no longer needed, both Caterpillar and Terex have also said they had thrown their order books open and invited customers to defer delivery of equipment. Both were surprised by the number of requests for delays they received.

"It keeps being worse than anyone, even these management teams, expected," said Bodnar at Longbow Research.

"If you'd asked them two months ago, 'Will you be laying anybody off?' or "What is the scale going to be?' the answer would have been nowhere near what it's now going to end up being."

DARKER DAYS AHEAD?

The reversal in the equipment industry's fortunes has been dramatic.

Back in September, at the industry's quadrennial trade show in Las Vegas, executives from Caterpillar, Joy Global and Terex all told Reuters they were optimistic sales to the mining and energy industry would hold up even though commodity prices were retreating.

At the time, Michael Sutherlin, chief executive of Joy Global, said that global mining fundamentals remained "extremely strong" despite the recent decline in the price of many key commodities.

"We have a lot of evidence forming up right now that indicates we're setting a new higher pricing floor for commodities," Sutherlin said. He had plenty of company.

Five months later, that confidence has vanished. The good times executives expected to go on for years because of the long underinvestment in the sector are as much as a memory as $146 a barrel crude oil, $97 a ton coal and $4.27 a pound copper.

With oil now struggling to stay above $40 a barrel, $57 a ton coal and copper trading around $1.40 a pound, energy and mining companies are closing mines, postponing plans to open new ones and cutting jobs and throttling back investment.

Ann Duignan, an analyst at JP Morgan, expects mining production cuts to continue and new project cancellations and delays to continue, and hurt the equipment makers well into next year.

Indeed, Duignan thinks the pain may be more intense in 2010 than 2009, because the companies still have some backlog to support them in the near term.

As a result, she says the big hit will come next year.

"Although strong original equipment backlogs may provide a source of support for mining equipment manufacturers in the near term, we believe the global recession will inevitably impact the sector and expect negative earnings revisions into 2010."

(Additional reporting by Nick Zieminski, Sonali Paul and James Regan, editing by Matthew Lewis)

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