Bearish Caterpillar Q2: Red Flag to 3 Mining Stocks

The world's largest maker of mining and construction equipment Caterpillar Inc. (CAT) reported a decline in its second quarter revenues yesterday mainly due to weak mining sales, signaling a dreary outlook for the mining industry.

Despite a 17% increase in its earnings, Caterpillar’s share price dropped as the market reacted to the 3% fall in revenues – the sixth sales decline in the past eight quarters. Caterpillar increased its earnings per share guidance for 2014 but scaled back its revenue guidance citing slowing demand in China and turmoil in Russia and the Middle East. Stronger sales of construction equipment in North America, mild recovery in Europe, and operational improvement were the saving grace for the company. This helped drive earnings growth despite lower sales.

Sales were mainly dragged down by a 29% drop in the Resource Industries segment’s sales, which primarily drives its revenues from the sale of mining equipment. Sales were down 35% to 40% in every region of the world except North America. The company noted that orders for mining machinery continue to remain weak.

Even though Caterpillar’s CEO, Doug Oberhelman pointed out that this was the first quarter since 2012 that Resource Industries sales had delivered a sequential improvement, it is too soon to suggest that the mining business is turning around.

Over the past two years, Caterpillar’s mining customers have slashed capital spending in the middle of a glut in capacity, drop in prices for coal, iron ore and other metals and slower economic growth in China and other developing countries. Caterpillar’s competitor Joy Global Inc. (JOY) has also borne the brunt of weak demand in the global mining market. To cope with weak mining demand, Caterpillar has resorted to cost cutting initiatives by closing down plants and laying off workers.

This bearish phase of the mining market has dealt a blow to Caterpillar’s long-term objective of becoming a dominant global player in the mining space. Prior to this, Caterpillar, had been riding the wave of heightened construction and mining activity in developing markets, triggered by the demand for coal, copper and iron ore. The company also, aggressively proceeded toward expanding in mining when the market was stronger. Its acquisition of Bucyrus in 2011 for $8.8 billion was an attempt to be a leader among the global mining original equipment manufacturers with the buyout resulting in the most expansive product offering in the mining equipment industry.

As a global supplier of mining and construction equipment, Caterpillar is considered a bellwether of economic activities. In line with Caterpillar’s poor outlook for the mining industry, we suggest three mining stocks to steer clear from at the moment.

3 Mining Stocks to Avoid

HudBay Minerals, Inc. (HBM)

Headquartered in Toronto, Canada, HudBay Minerals is an integrated mining company, which mainly focuses on the discovery, production, and marketing of base and precious metals in North and South America.

HudBay currently carries a Zacks Rank #5 (Sell). The stock has delivered an average negative earnings surprise of 122.92% in the past four quarters. Hudbay is currently trading at a P/E of 87.42, at a significant premium to the industry average of 30.28.

Primero Mining Corp. (PPP)

Primero Mining is engaged in the acquisition, exploration, development and production of precious metal properties in Canada and Mexico. The company explores for gold and silver. It owns interest in the San Dimas Mine, which is located in Mexico’s San Dimas district; and the Black Fox Complex that is located in the Timmins Mining District in Ontario, Canada.

Primero Mining currently carries a Zacks Rank #4 (Sell). This Vancouver, Canada-based precious metals producer is currently trading at a forward P/E of 87.65, a significant premium to the industry average of 15.00. The company also holds a negative earnings growth estimate of 76.39% for 2014 and an average negative earnings surprise of 38.34% in the past four quarters.

First Majestic Silver Corp. (AG)

Vancouver, Canada-based First Majestic Silver Corp. acquires, develops and explores mineral properties with a focus on silver projects in México. The company owns and operates five producing mines and two advanced-stage development silver projects.

This Zacks Rank #4 (Sell) stock is currently trading at a forward P/E of 33.26, at a premium to the industry average of 28.44. The company has delivered an average negative earnings surprise of 22.71% in the past four quarters. Moreover, First Majestic’s fiscal 2014 earnings is projected to drop 45.71% year over year.