CAT Analysis: Short-term Pain, Long-term Gain?

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Caterpillar (NYSE: CAT), a leading manufacturer of construction and mining equipment, power equipment and locomotives, is scheduled to announce 4Q12 and full-year 2012 earnings January 28. Its stock is up 12% over the past three months, but down more than 7% since last January. In the company’s most recent quarter it reported sales and revenue rose 5% year over year, with profit per share (including a pre-tax gain from a business sale) up 49%. However, it also lowered 2012 sales and profit guidance due to “global economic conditions that are weaker than we previously expected.”

As earnings approach, a SWOT analysis — examining the company's strengths, weaknesses, opportunities and threats — helps develop a clearer picture of how CAT performed at the end of 2012 and where it might be headed over the next several quarters.

Strengths

• Market position — CAT is the global leader in overall heavy equipment sales and the dominant player in critical categories like excavators and mining trucks. Its chief competitor in the former space is Komatsu, particularly in China, and in the latter it is Joy Global. Neither enjoys Caterpillar’s reputation or reach, however, particularly in the service arena. The company also has well established joint ventures in key markets like China, enabling it to offer lower priced locally made products in addition to higher-end machinery from its international line. Domestic competitors like Sany Heavy Industry and Guangxi LiuGong Machinery have made significant inroads but lag behind in “big iron” sales to the largest contractors and mines.

• Diversified products — No other company offers the breadth of products CAT does, which, along with its geographical range, has helped it weather the cyclical nature of its businesses. Construction and mining equipment are its most well known offerings, but power system profits hit nearly $1 billion in 3Q12 on sales of $5.3 billion. Leasing and service of diesel-electric locomotives and other rail products comprises a smaller segment but is still well established and adds to the diversified picture.

• Advancing technology — As we’ve detailed in posts in late December and earlier this month, CAT’s push into natural gas-powered machinery is also a big potential advantage. The company has made no secret of its intention to capture as big a share of this growing space as possible, developing related products like giant haul trucks and railroad engines. Its first three natural gas mining vehicles are expected within five years, along with power-generation equipment and marine engines.

Weaknesses

• European difficulties — In October CAT said it expects modest 2013 improvement in the U.S., China and most of the developing world, but continuing challenges in Europe. Largely because of that its initial 2013 outlook called for flat sales compared to last year. Since then economic policies in the Eurozone remain largely unresponsive to recessionary pressures and unemployment and unrest are unlikely to quickly dissipate. More upheaval could result if any countries choose to abandon the Euro.

• Dealer inventories — CAT dealers have responded to weak conditions by trimming their orders to cut inventory. CAT expects this to continue into the first part of 2013, although it has lowered production rates accordingly to help demand to catch up to supply.

• Bucyrus integration — When CAT completed the $8.8 billion acquisition of this mining equipment manufacturer in mid-2011, it projected a smooth transition with significant near term benefits. Impacts did turn positive in 3Q12 with the division realizing a net profit of $2 million compared to a net loss of $137 million in 3Q11, but results remain unimpressive and sales actually declined 4% year over year. On January 18 the company announced that Luis de Leon, the former Bucyrus COO who joined CAT as head of its Mining Products Division after the acquisition, would be leaving.

Opportunities

• U.S. construction — Improvement in the U.S. drove CAT’s North American sales up 9% in 3Q12. The company should further benefit from banks’ increasing willingness to lend, low mortgage rates, rising employment and a near-record inventory of new homes.

• Emerging markets — Developing countries, particularly China and Brazil, continue offering great promise even if their economies are slowing. China plans a massive increase in infrastructure development and banks there should boost lending, driving demand for construction and mining equipment. Brazil demand should also increase in 2013 as development begins for the upcoming Olympics and World Games it will host.

• Financial Products — A financing ancillary can be incredibly lucrative when your products cost millions, and in 3Q12 CAT Financial’s worldwide operating profit jumped 25% to $181 million. North America currently provides the most benefits, but the Asia/Pacific region has seen steady growth and there is potential for more as CAT’s products become further integrated into more regions and operations.

Threats

• Market conditions — The cyclical nature of CAT’s primary businesses always presents challenges, and its performance remains largely at the mercy of the world economy in general and specific economies in particular. Unemployment, consumer spending, corporate earnings and government investment are global issues that regularly impact CAT sales and any negative change in the mix could have an adverse effect.

• Commodities and costs — Downward pressure on metal and coal prices, combined with upward pressure on mine operating costs, negatively impacts mining company profits. This in turn delays capital investment, and lowers CAT sales. “Decisions to purchase our products are dependent upon the performance of the industries in which our customers operate,” the company said in October.

• Emissions-compliant products — As regulatory agencies worldwide adopt more stringent machine and engine emission standards, challenges to CAT (and other equipment makers) increase. Efforts to meet new requirements in the U.S., EU, Japan, Canada and other regions face many variables, and missteps could hamper sales. Such efforts also incur significant costs, and the ultimate acceptance of these new products, and the price points at which they are positioned, remains unknown.

Conclusion

Caterpillar is the leader in a large and lucrative global space, dogged in all corners of the world by a pack of hungry competitors who have peeled off market share, but not really lessened its dominance. Diversified products known for high quality, and a continual introduction of new technologies, should keep CAT well positioned even as a variety of challenges threaten its short-term performance. Fourth quarter and full-year earnings may be weaker than projected early in 2012 but in line with recent company guidance. Sales this year may likewise start soft, but could pick up appreciably if U.S. and emerging market upward trends continue.


Fool blogger Howard Rothman does not own shares in any of the companies mentioned in this entry. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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