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Remain Cautious About Caterpillar

I believe that this was the main positive in the latest earnings release. With improving macroeconomic fundamentals, the business could make up for some of last year's under-performance by posting increasing revenues from the construction industries and power systems segments.

Another positive was the 20% growth in sales in China. Caterpillar is expecting 7.5% economic growth in the country. This will translate into a "moderate" growth of the construction industry, which should translate into improving sales.

Struggling Core Business

Caterpillar has struggled in the past due to weakness in the mining industry. This was mainly due to the fall in metal prices. Furthermore, some unpopular takeovers, project delays and reduced capital spending by mining companies made things even more difficult for everyone in this industry. These factors severely hurt Caterpillar's sales of mining equipment, which are represented in its resource segment.

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The resource segment has been the primary revenue drive for Caterpillar in the past several years. But in the previous quarter, the segment's revenues plunged 48% from last year, to $3 billion. This makes resource the smallest of the three main segments that make up its machinery and power systems unit, from which Caterpillar derives nearly all of its revenues.

Although there have been some positive signs, such as reduction in inventory, there is still no turnaround in sight. The order rates for new equipment remain extremely low.

Caterpillar's management is optimistic about its long-term prospects, since mining equipment sales could pick up in the coming years. But it is almost certain that the unit will remain under pressure throughout 2014. Therefore, Caterpillar is expecting a further 10% drop in revenues from its resource segment in 2014 from 2013.

Besides Caterpillar, other players in the industry are also struggling with declining sales. In its previous quarterly results, Joy Global (JOY) witnessed a 16% decline in underground mining equipment sales and a 36% decline in surface mining equipment sales. Meanwhile, Komatsu (KMTUY) the world's second-largest manufacturer of construction and mining equipment, significantly reduced its profit forecast in October and has reiterated its dim guidance, despite posting better results.

In short, amid persistent weakness in the mining sector and in the absence of any top line growth, Caterpillar has to rely on its cost-cutting measures to boost its earnings,. For 2014, the company is expecting annual revenue of around $56 billion and earnings of $5.85 per share, excluding the restructuring costs.

Caterpillar essentially thinks that its revenues in 2014 will be in line with last year's results. However, shareholders should take this guidance with caution.

Caterpillar has a history of over-promising and then revising down its outlook, and the company will incur substantial restructuring charges in 2014. According to its guidance, that will drag earnings down by 55 cents per share. Moreover, this profit forecast could also be revised downwards.

At the time of publication, the author held no positions in any of the stocks mentioned.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

Sarfaraz A. Khan is a capital market analyst and finance writer. Khan earned an MBA from the University of Aberdeen, located in the heart of the UK's oil and gas industry. Not surprisingly, his specialty lies in energy stocks. He also covers consumer goods, services sector, technology stocks, emerging markets and ETFs. His work appears on Seeking Alpha, Motley Fool and TheStreet.
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