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Analysts predict growth in China for Caterpillar

by Savannah Ziegelbauer
Feb 05, 2010

Analysts are expecting Caterpillar Inc. to have a great year—in 2011. And the reason is China. 

“They’re building out their roads, continuing urban development and continuing modernization,” said Adam Fleck, an analyst at Morningstar Inc., “and whether or not they tighten their monetary policy or loosen their monetary policy, over the long-term, multiyear, I think Caterpillar is poised to benefit from the demand there that is inevitable.” 

Like the analysts who cover it, Caterpillar, the Peoria-based bulldozer and excavator manufacturer that boasts no fewer than 11 plants in China, expects long-term growth in China’s robust economy, particularly in the mining segment. But on 2010, analysts are divided, especially since China recently tightened its monetary policy to cool the rate of economic expansion, meaning investors may be less likely to stick money into mining-related activities. 

According to a compilation by Bloomberg LP, the analysts’ consensus regarding Cat’s diluted earnings per share this year is $2.60, up from a very depressed $1.43 per share last year, but their estimate for 2011 leaps again, by more than half, to $4.01 per share. Bloomberg says 54 percent of Cat analysts rate the stock a “hold” and 34 percent call it a “buy.” 

Caterpillar’s net income last year was $895 million, down 75 percent from 2008, on revenues of $32.4 billion, which were off 37 percent from 2008. The company stated in its fourth quarter earnings release that it expects a 10 percent to 25 percent growth in sales for 2010. 

China is the key. “I think there’s a high probability they’ll be able to sustain growth between eight and 10 percent,” said Cat CEO Jim Owens, “while moderating a little bit coming out of the very aggressive stance they took with monetary and fiscal policy to stimulate growth in the face of a dramatic drop in their exports to the rest of world and sustain employment.” 

In late 2008 China responded to the global financial crisis by passing a spending package valued at $586 billion. The money was spent on national infrastructure projects and social welfare programs. 

According to the National Bureau of Statistics of China, its gross domestic product grew by 8.7 percent in 2009. The growth of heavy industry was 11.5 percent and light industry grew by almost 10 percent. 

Caterpillar has been doing business in China for nearly four decades. On top of its 11 plants it operates 10 business offices there, altogether employing more than 5,800.  

Moningstar’s Fleck said that China has become the major demand center for commodities such as iron ore, coal and other extractions. Therefore, he cautions, “if China were to pull back on their own demand because of tightening monetary policy, it could drive the prices down for those commodities.” Should that occur, Fleck went on, Caterpillar customers worldwide may not want to invest in new mines, which means fewer purchases of Cat’s mining equipment. 

 Ultimately, Fleck said, the demand for Caterpillar’s mining equipment is measured by whether commodity prices are high enough to encourage further investment. 

Ann Duignan, an analyst at J.P. Morgan Chase & Co., wrote in a research note that as long as global gross domestic product is positive for 2010, then demand for commodities should maintain relatively robust. 

She said Cat’s mining equipment sales may benefit from the recent sell-off in commodities because it appears to have been driven by the exit of speculators. This may be positive for mining operators because now prices will be driven by the fundamentals, she said. 

Duignan rates the stock “overweight” and assigns it a target price of $65, substantially higher than recent trading around $51, with diluted earnings per share estimated at $3 for 2010 before a big jump to $3.97 per share next year.

Cat’s price-earnings ratio of 29 already puts it10 points higher than the Standard & Poor’s 500 Stocks’ P/E. The stock’s 52-week low was $21.71 and the 52-week high is $64.42. The stock has been trending upward since it hit the low in March. 

Robert Wertheimer, an analyst at Morgan Stanley and Co. Inc., rates Cat “underweight,” but raised his earnings estimate for 2010 from $1.79 per share to $2.15 because of “an improved revenue outlook, mainly on improving mining, but also on Cat’s inventory performance.” Nevertheless, he foresees no advance in the stock this year: he assigns a 2010 target price of $51, the current market. 

Wertheimer’s estimate is more bearish than the analysts’ consensus of $2.60 per share. He believes there is a broad range of outcomes possible for 2010 “from little more than $1 in earnings to well more than $3 if oil/gas engines were to recover near term and Cat hit the top end of its revenue range. 

While Cat expects growth in the U.S. and other western countries to come from dealers replenishing their inventories, Fleck, of Morningstar, said that is not the way Cat functions in China. 

He said Cat’s China operations have more of a two-tiered approach. It has a similar dealer network to that of North America and Western Europe, which has a good reputation of service and support. But the difference is that Cat draws attention to that network by teaming up with a lower-priced manufacturer called Shangdong SEM Machinery Co. Ltd. 

“And they go in with that brand and try to compete against some of the lower value, lower priced type of products that many of their competitors are offering,” Fleck said. “As customers themselves prefer more advanced equipment and see the value of the support network, they would naturally move into Caterpillar equipment.” 

In 2009 Cat saw drops in its machinery and engine sales across all regions, but the Asia/Pacific region’s sales suffered the least, declining just 19 percent. In 2009, 62 percent of Cat’s revenue came from locations outside of the U.S., compared with 66 percent the year prior. With the exception of the U.S., Caterpillar does not break down sales by individual country, only by region. 

Caterpillar attributed the decline in Asian sales to governments’ and central banks’ reacting aggressively to the worldwide economic downturn. 

Last December Caterpillar and government leaders in China opened a new multi-functional research and development center in Wuxi, Jiangsu province. The center is located near several Caterpillar manufacturing plants.