Gauging the Health of the US Economy – Part 1

By Mike Richardson - December 17, 2012 | Tickers: CAT, DE, JOY | 0 Comments

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The political pundits have had their way with the microphones and keyboards for far too long.  The headlines and talking heads have a sense of distorted reality that, unfortunately, confuses the general public and leads to greater investor uncertainty.  With the clouds of hot air finally evaporating from the campaign trails, it’s time to find some true barometers of the overall US economy. 

For the last two years, the constant theme has been that the US is not growing fast enough and another recession is looming.  Given that the stubbornly low GDP figures feed such perspectives, these quarterly numbers are merely a surface-based view of what requires a deeper analysis.

To take a full account of the US economic health, one can look at the industrial sector to determine how strong the future will be.  The domestic bellwether in this space is the heavy machinery giant Caterpillar (NYSE: CAT). CEO Douglas Oberhelman made news in October when the company released its third quarter results and issued a downward revision of its overall forecast for 2012.  CAT reported net income of $1.7 billion for the most recent three-month period, which was well above the $1.14 billion from same time frame last year. 

Despite the 49% year-over-year increase in net income, Oberhelman stated that they are anticipating a temporary slowdown in the months ahead.  This was precipitated by revenue numbers coming in at $16.45 billion which was lower than the $16.77 billion that had been projected for the quarter.

To judge the depth of this expected decline in CAT’s financials and put into some context, one can begin by reviewing the past six years of annual earnings:

Net Income

Steady profit was the norm for this Industrial powerhouse from 2006 – 2008, and then the bottom fell out of the company’s earnings with the “Great Recession.”  The ensuing rebound has produced a combined total net income for 2010 and 2011 that yielded $680 million more than the two years prior to the decline.

Gross Revenue

From the gross revenue perspective, CAT enjoyed consistent gains each year pre-recession, peaking in 2008.  Likewise, since the set back in 2009, the company has stair stepped its sales to new highs.  If the 2012 projections prove true, Caterpillar is poised to more than double its revenue from its low point three years ago.

Like any well established company, contingencies were in place to combat any softness in the marketplace.  Management announced that the decision had been made for CAT to use existing inventories and idle some of its manufacturing plants in an effort to contain costs and maintain consistent earnings.  This is a telling stat as excess supply ballooned in 2011, as is illustrated in the table below:

Annual Inventories

Despite the significant increase in the stockpile of construction equipment over the last two years, CAT has maintained a healthy profit margin relative to the average seen in previous years:

Net Profit Margin

The final analysis on CAT stands at a crossroads.  While the company’s revenue and net income are at peaks, the recent moves to shutdown manufacturing and work from excess supply until demand returns show real concern about the headwinds affecting growth in the near term.  Oberhelman has been quoted as saying he “does not expect the global economy to begin improving until the second half of 2013.”  The multi-national firm will continue looking for resurgence in China and emerging markets for renewed sales while many large scale domestic expansion plans remain on hold until the fog lifts from the American fiscal landscape.

This assessment is shared by Caterpillar's peers, as well.  Joy Global (NYSE: JOY) does not expect a quick rebound in orders for mining equipment, especially in its coal production business.  The US and China are showing significant slowdowns in such projects, and, with these countries being JOY's two largest markets, the company is bracing for a decline in its revenue during the new year.  In similar light, Deere & Company (NYSE: DE) has dampened its outlook by projecting agricultural equipment sales to be flat in the US and Canada as a result of farmers continuing to recover from the harsh drought of 2012.  With domestic prospects being slim, DE will follow the plan of its competitors by looking at its international portfolio for upside potential in the year ahead.  Thus, Deere has pinned its hopes on South America to generate a 10% growth rate to counteract sluggish activity elsewhere.

The outlooks put forth by leaders in the industrial sector directly translate to the overall US economic health.  Policymakers have allowed uncertainty over national debt and budget issues to stifle business plans at home.  Thus, corporations continue hoarding cash in lieu of putting funds to work in new commercial building projects.  Corporate reinvestment would lead to job creation and greater confidence within the private sector that the path forward was more secure.  Doug Oberhelman’s perspective for CAT can prove true for the country as a whole . . . the first half of 2013 could be a rough patch for the American economy, and all eyes are focused on a second half comeback.

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