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 More than half of Caterpillar's sales are from construction equipment.

It's a depression in construction equipment, but giant Caterpillar muscles on

by Jeniece Pettitt
Dec 03, 2009


Caterpillar Inc./
Jeniece Pettitt/ MEDILL

Asia-Pacific sales, 17.5 percent of the total last year, are increasing further this year.


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Caterpillar Inc.

As the construction equipment industry endures what it considers a depression, Peoria-based giant Caterpillar Inc. is managing remarkably well by decreasing inventories and cutting costs, and will rely on international recovery to resume growth.

“China, India and Brazil are the key for Caterpillar,” said Charlie Rentschler, vice president of Wall Street Access Corp. “Dealer demand and final customer demand have to get cranking and it will be caused by an upturn in global economies.”

Caterpillar has been around for more than 80 years and manufactures mining and construction equipment, industrial gas turbines and engines in 23 countries and sells products in 200 countries worldwide. A majority of sales are international. In 2008 62 percent of revenues were from machinery sales, 31 percent from engines, and 6 percent from loans and other financial products.

Caterpillar cut approximately 18,000 full-time and 18,000 part-time employees since the end of 2008. As of September 2009, worldwide employment for was 94,225 employees.

Two out of every 25 jobs lost in the U.S. is tied to the slumping equipment industry, worse than the auto and finance industries, according to a recent study by IHS Global Insight. In a peak-to-trough context, construction equipment output will decline from $35.1 billion in 2006 to only $17.5 billion in 2009, according to the study.

“While the broader economy may have begun to recover from the great recession, our industry is still in a depression,” said Toby Mack, president of Associated Equipment Distributers Inc. “The national economic output of the equipment industry has contracted by nearly 40 percent, and resulted in the loss of 550,000 jobs. That’s 8 percent of all jobs in the United States since the start of the recession.”

Despite the gloom, a majority of analysts who follow Caterpillar recommend holding the stock. Their average target price, according to a Bloomberg LP survey, is $60.80. The stock closed Thursday at $58.20.

Rentschler said Caterpillar has done an incredible job managing operations during the downturn.

“Their operations have really buffered this company on the way down,” Rentschler said.

LawrenceDe Maria of Sterne, Agee and Leach Inc. upgraded his outlook for Caterpillar to neutral from sell and set a target price at $64 after the company’s better-than-expected third quarter earnings, although they were down 53 percent to $404 million, or 64 cents per diluted share, from the year-earlier period. In a note, the analyst wrote that Caterpillar’s inventory restocking at dealers will help margins even if demand stays weak and that the company will be well positioned for an eventual complete recovery.

“The worst is most likely over,” the note stated.

But after the third quarter, Barry Bannister and Elizabeth Lintner of Stifel, Nicolaus & Co. Inc. lowered their rating from hold to sell, with a target price of $49.

“The CAT stock valuation does not appear to account for the time value of money, in our view,” they wrote in a note. “The stock advance this cycle is clearly ‘ahead of itself.’”

They noted that they do not see domestic machine demand growing until 2011, besides inventory re-stocking. They also believe that sales in developing countries will be less profitable than sales in established western markets.

After the third quarter Caterpillar raised its full-year profit outlook from $1.10 to $1.30 per diluted share. The outlook for sales and revenues is a range of $32 billion to $33 billion. In 2008 Caterpillar earned $3.56 billion, or $5.66 per diluted share, on $51.32 billion in sales and revenues.

Caterpillar predicts 2010 sales and revenues to be up by 10 percent to 25 percent from the 2009 projection, with growth led by developing economies.

Adam Fleck, Morningstar Inc. equity analyst, was “surprised” by Caterpillar’s positive outlook for 2010 since he has been modeling 2011 as Caterpillar’s bounce-back year. He added that growth in developing countries will be important in helping Caterpillar reach its goal.

In 2008 61 percent of Caterpillar’s total revenues came from international sales and $8.98 billion was from the Asia Pacific region, or 17.5 percent. However, in the first nine months of this year sales from Asia rose to more than a fifth of total sales — 21.7 percent of $24.5 billion.

In its third quarter earnings release, Caterpillar stated that dealers in China had their best third quarter ever for machine deliveries. It attributed the increase to the Chinese government’s stimulus program and a more than 30 percent expansion in credit availability compared with 2007.

Construction growth in Asia, excluding Japan, is expected to increase from an anticipated 5.9 percent in 2009 to 7.1 percent in 2010, according to a November report by IHS Global Insight.

Caterpillar said it is experiencing increased orders for mining products compared to what it experienced during the beginning half of 2009. Mining accounted for 25 percent of the company’s machinery sales in 2008, the second biggest seller after heavy construction sales, which account for 28 percent of machinery sales.

Worldwide demand for certain metals, such as copper and nickel, is on the rise, according to Carol Raulston, spokeswoman for the National Mining Association.  She explained that basic economic drivers affect the demand for metal such as infrastructure development, automobile production and homebuilding construction. Ten percent of the coal mined in the U.S. goes to steel production and it is starting to see an uptick.

“Worldwide demand for metals is starting to go up again,” Raulston said. “Manufacturing in China is now growing at 14 percent.”

To give an idea of how much the mining industry affects the total equipment industry, $5.96 billion was spent on new machinery for mining in the U.S. alone in 2007, according to Raulston.

Stimulus programs in the U.S. and worldwide will have most the impact in the first half of 2010, Caterpillar stated in a press release.

“It’s hard to know how much the stimulus has done for the industry,” said Christian Klein, vice president of government affairs at the Associated Equipment Distributors. “It’s been more of a life support. Things could be much worse if they didn’t have the stimulus.”

De Maria of Sterne, Agee & Leach said government infrastructure spending has been less than expected and has had minimal impact.

“It generally does not have much effect on Caterpillar,” De Maria said, explaining that many of the stimulus projects have been for smaller construction projects, such as road repaving.

Klein of Associated Equipment Distributors noted that the industry is optimistic that earth-moving projects are starting up around the U.S., which could directly benefit Caterpillar, due to another injection of stimulus spending.