Here's Where Things Get Really Ugly for Caterpillar

After reporting some horrible numbers over the past year, heavy-equipment manufacturer Caterpillar looked like it finally bulldozed its way out the deep hole it dug. Shares have climbed nearly 25% above their 52-week low, helped along by higher sales of power systems even while dealer retail sales of heavy equipment continue their global decline. But now comes the part where the other shoe falls.

Actually, shoes have been falling all over the place, but now is when they will leave the deepest scar on Caterpillar. With the U.S. coal industry under assault, China's economic "miracle" is coming unglued, sending prices for both copper and iron ore tumbling and imperiling the entire mining sector.

Trade data released this past weekend showed Chinese exports collapsed more than 18% in February from the year-ago period; this is compared to analyst expectations of a 7.5% increase and down from the double-digit growth export achieved in January. The world's second-largest economy is entering a much worse tailspin than many previously believed possible.

In response, copper prices plunged to a seven-month low yesterday as inventories surged higher, raising concerns that not only is copper mining in trouble, but that China's financial markets are about to unravel -- the red metal is used as collateral to make loans to companies and investors. The falling price could create a domino effect that causes a call for covering the debt to be issued, leading to dumping copper stocks and further pressuring the price.

Similarly, iron-ore pricing recently dropped to its lowest level since last June leading to a similar ripple effect throughout the mining industry. Shares of BHP Billiton fell 2.7% yesterday and are down almost 9% from the recent high hit just weeks ago, while Rio Tinto declined 2% on Monday and is down more than 12% since hitting a 52-week high in late February. Sure, there was some exaggeration in the trade data due to Chinese New Year holidays, but the numbers still suggest a substantial weakening of the world's second-biggest economy that carries global ramifications.

And nothing good for Caterpillar, either. BHP and Vale have both been reining in their capital expenditures. BHP recently sold its position in its Australian Jimblebar iron-ore mine and Vale, the world's biggest iron-ore miner, has cut its capital expenditure program for the third year in a row. Rio Tinto has also slashed its budget by $3 billion to $11 billion for 2014.

With miners sharply pulling back, a move that may not be enough in light of current events, we could see further cuts imposed. Joy Global, which is more exposed to coal's curtailment than Caterpillar (two-thirds of its sales coming from coal miners), reported last week that first-quarter revenue plunged another 27%, with original equipment sales cut in half. Bookings, which were down 19% in the fourth quarter, dropped another 16% in the first.

China accounts for about 28% of Caterpillar's Asia-Pacific region sales, or 6% of total revenue, about double what it did the year before. The heavy-equipment maker placed more emphasis on the country to bolster sagging sales elsewhere; now that the underpinnings of the Chinese economy are buckling the risk to Caterpillar grows exponentially, especially because so much of the rest of the global economy relies upon China. 

Caterpillar's stock may have bounced higher because it was so undervalued, but I think the cycle has run its course and a potential collapse in China may cause the next falling shoe to squash its shares once more.