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A weekly column that attempts to warn investors about outright scams, stocks that seem overpriced on the basis of their current assets, future outlook, and financial results.

Whither Finning as short seller targets Caterpillar?

Peter Kennedy Peter Kennedy, Stockhouse Featured Writer
0 Comments| July 17, 2013

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U.S. equipment giant Caterpillar Inc. (NYSE: CAT, Stock Forum) is the latest target of high profile U.S. short seller Jim Chanos.

Speaking to institutional investors at the Delivering Alpha Conference in New York, Chanos said Caterpillar will be a victim of a slowing Chinese construction boom, which will spell an end to the commodities supercycle, reducing demand for mining equipment in its wake.

“We are short Caterpillar Inc.” said Chanos, a founder and managing partner of New York-based Kynikos Associates, LP, which has $6 billion in assets.

He described Caterpillar as an iconic American company that remains tied to mining equipment at the wrong time in the cycle.

Such comments might also be applied to Finning International Inc. (TSX: T.FTT, Stock Forum) a Canadian company which Chanos failed to mention, even though Finning is the world’s largest Caterpillar dealer, with 15,300 employees worldwide and operations in Western Canada, South American and the British Isles.

Trading at $23.40 this week, down from over $27 in late February, Finning has a market cap of $4 billion, based on 172 million shares outstanding, and trades in a 52-week range of $27.30 and $20.91.

Chanos did not provide a stock price target for Caterpillar, which eased 1.7% Wednesday to $86.67, leaving the company with a market cap of $57 billion, based on 657.5 million shares outstanding.

However, he made the following assertions in relation to his decision to go short on the stock.

“I believe that the commodities supercycle, which has been built on the back of the Chinese construction boom is coming to an end,’’ he said.

“Now keep in mind that the Chinese construction boom shows no sign of ebbing, despite credit problems that are beginning to appear. But consider that one company on the Dow Jones has 30% of its revenues and 50% of its operating profit tied to global mining capital expenditures.”

He estimated that global mining capital expenditures grew 8% per year from 1990 to 2001, marking the first leg up on the commodities supercycle. They then grew in the last 10 years at a 24% annual clip from $14 billion to $145 billion annually.

“And when you consider that one third of global mining cap ex is equipment, that lands you at the doorstep of Peoria, Ill.based Caterpillar Inc., an iconic American company and a leader in its class., but tied to mining products at the wrong time in the cycle,’’ he said.

Chanos said Caterpillar currently trades at 12 to 13 times earnings, which are not expected to grow reasonably at all in the next few years, he said.

He went on to note that the bulls expect mining cap ex to decline.

“But here’s the problem: they expect it to decline gradually at a rate of about 10% to 15% per year. But if you consider that cap ex in the mining area was over $30 billion between 2006 and 2007 and got to $145 billion two years ago, the declines are still meaningfully above what were historical levels.”

Chanos is taking the view that the Chinese real estate bubble has driven capital spending on mining equipment to a level that far exceeds the historical average. It follows then that the Chinese slowdown and the end of “global commodities supercycle” will inevitably drive spending back down to something closer to historical levels.

Meanwhile, in discussing its first quarter results, Finning said it experienced slower activity in mining during the first quarter of 2013, resulting in lower order intake.

The Vancouver, British Columbia company also said consolidated revenues this year are expected to be flat to up to 10% over 2012.

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