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WIKI ANALYSIS
Caterpillar (NYSE: CAT) manufactures heavy-duty vehicles and technologies designed for constructing buildings and mining the earth. Worldwide, Caterpillar is the leading manufacturer, by revenue, of engines and turbines used in machinery, electric generators, highway and non-highway trucks, and seaborne vessels.
During the eight years before 2009, CAT has seen unparalleled growth, largely on the back of a booming U.S. construction market, higher petroleum exploration and production, and growing demand for its equipment overseas. Caterpillar still managed to post record sales and profits during the 2007 subprime lending crisis, due to demand for infrastructure in emerging markets. Caterpillar posted record sales in 2007, which collapsed and moved in the red by 2009.[1] The global economic slowdown and commodity price collapse caused demand for mining machinery to dip below 2007 levels during the fourth quarter of 2008.[1] The company has increased in presence in several key regions such as China, which has seen unprecedented wealth growth and has a huge appetite for energy.
Though dependent on the declining US housing construction market, Caterpillar has diversified its sales internationally, aided by the global boom in infrastructure development.
Company Overview
With nearly 95,000 employees, Caterpillar's global footprint spans six continents and boasts the highest worldwide sales of its competitors. In addition to manufacturing and selling machines and engines, Caterpillar also provides financial products to its customers. Its three main businesses generated 51.3 Billion in 2008, but have been hit hard by a collapse in commodity prices.
In May 2009, Caterpillar (CAT) sold 43% less than it did the previous May, [2] which means that the Company could cut slash quarterly dividend to 10 cents a share from 42 cents, according to Merrill Lynch analysts.[3]
Despite these disturbing reports, the Company has been trying to improve its image by launching a blog and making hybrid tractors that pay themselves off in 2 years due to fuel savings.[4]
The company has 3 primary segments: Machinery, Engines, and Financial Products. In 2008, Machinery and Engines accounted for 88% of the company's profit. Financial Products accounted for 12%.
Machinery: the design, manufacture, marketing and sales of construction, mining and forestry machinery—track and wheel tractors, track and wheel loaders, pipelayers, motor graders, wheel tractor-scrapers, track and wheel excavators, backhoe loaders, log skidders, log loaders, off-highway trucks, articulated trucks, paving products, skid steer loaders and related parts. Also includes logistics services for other companies and the design, manufacture, remanufacture, maintenance and services of rail-related products.
Engines: The design, manufacture, marketing and sales of engines for Caterpillar machinery; electric power generation systems; on-highway vehicles and locomotives; marine, petroleum, construction, industrial, agricultural and other applications; and related parts. Also includes remanufacturing of Caterpillar engines and a variety of Caterpillar machine and engine components and remanufacturing services for other companies.
Financial Products: Cat Financial provides a wide range of financing alternatives to customers and dealers for Caterpillar machinery and engines, Solar gas turbines as well as other equipment and marine vessels. Cat Financial also extends loans to customers and dealers. Cat Insurance provides various forms of insurance to customers and dealers to help support the purchase and lease of our equipment. Cat Power Ventures is an investor in independent power projects using Caterpillar power generation equipment and services. [4]
Business Financials
Quarterly and Annual Financial Updates
Q3 FY 2009
Quarterly earning summaries for CAT reflect drops across the board as the company suffered losses from machinery and engine sales as well as drops in financial product revenues. CAT announced a 44% loss in sales and revenues, from $12.9 billion in Q3 of FY 2008 to $7.3 billion.[5] Q3 profits were $404 million, down from $868 million in Q3 of FY 2008, a 53% drop.[5] These declines were driven by a drop in sales volume, both in machinery sales and in engine sales by 52% and 35% respectively in comparison to the third quarter of last year, as well as a 14% decline in financial product revenues.[5]
Q1 FY 2009
The last quarter has been extremely difficult for Caterpillar. Saddled with a heavy debt to equity ratio, Caterpillar is taking a defensive cost-cutting strategy for the next quarter. This includes pay-cuts, layoffs, hiring freezes, reduction of indirect expenses, fewer capital expenditures, less overtime pay, shortened workweeks, partial plant shutdowns and a general cost reduction strategy.
These strategies seem to have paid off in terms of increasing the Company's free cash flow. In the first quarter of 2009, the company generated $450 million in free cash flow, a 638% increase from the $61 million it generated in Q1 of 2008. High free cash flow helps debt-heavy firms finance themselves.[6]
For 2009, the company predicts revenues of $36-44 billion, and profits of about $2.00 per share. This will be down 25% from 2008 figures. [7]
Despite recent difficulties, Caterpillar's net profit margin has hovered around 7.6%, whereas the industry average is only 3.5% for the last 5 years. [8]
Caterpillar's profitability arises due to Economies of Scale and an ability to charge a higher price point due to its better distribution and reliable machinery. It has superior distribution networks due to its massive size. Its next largest competitor is Deere & Company (DE) , which is $3 billion or 15% smaller than Caterpillar. [9]
Caterpillar sales outside the United States were 67 percent of consolidated sales for 2008, 63 percent for 2007, and 54 percent for 2006. Thus, Caterpillar has a strongly diversified international revenue stream, and is investing billions into expansion in Asia and India. Specifically, it is buying up major machinery plants in China and Singapore, and building plants to support a large road project in India near Chennai. From a financial standpoint, this means that Caterpillar's returns are not strongly tied to the dollar. [7]
Trends/Risks
The success of Biofuels may enhance agricultural equipment sales
Caterpillar's agricultural equipment sector will prosper if the nation has to harvest massive amounts of corn or soybeans to fuel its vehicles. It takes about 21 pounds of corn to make 1 gallon of ethanol, which would mean much more demand for Caterpillar's tractors if corn based ethanol took off.
The demand for Ethanol and biofuels peaked in 2008 along with gas prices, only to falter in 2009. People only consume biofuels, it seems, when gas prices are extremely high. For instance, the Midwest has seen a 52% drop in ethanol consumption, with only a 3% drop in gasoline consumption. Ethanol is about 15-20% less efficient than gasoline, and studies have shown it needs to be about 40 cents cheaper per gallon to compete. [10] This implies that gas prices need to be relatively high for Caterpillar to benefit from the biofuel trend.
And the biofuel trend might miss the point. New research done at UC Merced and published in the journal Science in May 2009 presents evidence that crops yield 81% more energy per unit area of land when it is burned to make electricity to power cars than when it is refined into ethanol.[11] Furthermore, greenhouse gas emissions from this "bioelectricity" are 100% lower per unit area of land than cellulosic ethanol.[12] Certainly, Caterpillar would benefit from a switch to corn-based power, but not as much if that power does not require the excessive harvests that ethanol does.
It is also possible that Caterpillar tractors will not be used to harvest biofuels in the future. In July, 2009, Exxon Mobil (XOM) entered a five-year, $600 million partnership with Synthetic Genomics Incorporated, to develop algae-based biofuels.[13] Algae grows in the ocean, where Caterpillar equipment does not work very well.
Tax treatments of Amortization and Depreciation expense determines the present value of Caterpillar equipment
You would rather have a dollar today than tomorrow, so if you can record depreciation expenses on your equipment sooner, rather than later, then you are better off (you save on taxes now, rather than later). One reason why firms feel better about making large capital investments in Caterpillar equipment is that it is tax deductible. Look out for any changes in the tax treatment of depreciation. More stringent rules hurt Caterpillar because their machines lose value from a tax perspective.
U.S. Environmental Legislation and international green movements could decrease or increase demand for Caterpillar's equipment
The EPA has tougher standards, and just passed a Tier 4 non-road diesel requirement that will start affecting most of Caterpillar's nonroad machinery and engine products starting in 2011. Higher standards force Caterpillar to incur R&D expenses to make their products complaint. At the same time, Caterpillar is the largest company in the agricultural machinery space and can most easily afford these R&D expenses. The company could gain severe competitive advantage by developing and patenting a machine that meets environmental standards, if its competitors were unable to do so.[14]
Obama's Presidential Policy features explosive infrastructure spending which could increase demand for Caterpillar equipment
It is likely that the Obama administration will allocate about $136 billion to the states in order to fund road, bridge and water projects. Such an infrastructure overhaul has not been seen since the 1950s. [15]
Watch Caterpillar's website to see if it is getting contracts for state infrastructure projects. An exclusive contract could seriously bolster the company's bottom line. Infrastructure is about 5 times as equipment intensive as road and traditional construction work, which makes this possibility more enticing.
Increasing demand in the Third World
Rapid growth of Emerging Markets like Mexico, China and India all could benefit Caterpillar, which has distribution networks to provide worldwide industrialization projects with equipment. More than half of Caterpillar's revenue is international, and that number is increasing. For the second quarter of 2008, sales increased 52% for Asia/Pacific, 27% for Latin America, and 22% for Europe/Middle East/Africa. [16]
From an economic perspective, machinery has a higher marginal utility in places where it is underutilized. If a town has no tractors, 1 more tractor is far more significant than it would be for a town that already has 80 tractors. Thus, Caterpillar equipment will drive more value in developing markets. Look out for the stability of these markets, as their continued development bodes well for Caterpillar's business. Of course, political change, terrorism, and corruption are also risks worth following because they are associated with the governments of most developing countries.
Exposure to commodities price volatility
The company's products are used across various commodity industries, including lumber, oil, coal, and elements which require excavation such as precious metals, stone, and minerals. When the price of commodities go up, more people buy machines to dig them up. At the same time, the machines cost more to make, which hurts Caterpillar.
The above graph of the Baltic Dry Index shows that commodity prices peaked in early summer 2008 before crashing abruptly. Commodity price volatility does not help Caterpillar (CAT). Machinery is a big investment. Sure the price of corn might be really high today, but by the time you harvest it, it might be worth nothing. Does that make you want to buy an expensive tractor? No. If you have a tractor and it's not paying for it's lease, do you think you are more or less likely to default on your payments?
The Recovery of the US Housing Market
The US Subprime lending crisis led to a decline in home values which undermined Caterpillar's consumer facing equipment sales. Real Estate Developers simply do not need to buy new equipment to build new neighborhoods- they need to worry about their tanking investments. To monitor the performance of the US real estate market follow the IShares Dow Jones U.S. Real Estate Index Fund (IYR). It is down over 30% since July 2008 and is showing no immediate sign of recovery.
Competition
Caterpillar (CAT) plays in the large-cap, international Construction, Agriculture and Machinery Industry. Other companies include Deere & Company (DE), Kubota (KUB), Fastenal Company (FAST), Joy Global (JOYG), and CNH Global N.V. (CNH).
Caterpillar is the 800 pound guerilla in its space, with its annual net income exceeding that of its next 4 major competitors. But despite its huge size, Caterpillar has underperformed its peers for the last 5 years, still riding the momentum of decades of performance.
Its competitors have regional strength, because geography in the heavy machinery business matters (shipping cranes is never cheap). Komatsu, for instance, competes with Caterpillar strongly in Japan. Additionally, many international competitors have lower labor costs because Caterpillar (CAT)'s US employees demand higher wages for their work.
Caterpillar competes in several different markets, where it tends to dominate. The following charts show you how Caterpillar does relative to AGCO (AG), FIAT S.p.A. (F-MI), Kubota (KUB), Deere & Company (DE),CNH Global N.V. (CNH), and Terex (TEX) which are its primary public competitors.
References
- ↑ 1.0 1.1 CAT 2008 10K
- ↑ H. J. Heinz Company F2Q08 (Qtr End 10/29/08) Earnings Call Transcript.
- ↑ Analysts cut dividend projection for Caterpillar.
- ↑ 4.0 4.1 Analysts cut dividend projection for Caterpillar.
- ↑ 5.0 5.1 5.2 http://www.cat.com/cda/layout?m=37422&x=7 Caterpillar Reports Third-Quarter Profit and Raises 2009 Profit Outlook]
- ↑ Seeking Alpha on CAT.
- ↑ 7.0 7.1 CAT 10k p.6.
- ↑ Motley Fool Industry Tables.
- ↑ Google Finance Industry Tables.
- ↑ [http://news.yahoo.com/s/ap/20090714/ap_on_re_ca/us_farm_scene_e85_outlook | Yahoo News: Massive Ethanol Decrease in 2009]
- ↑ CNET: "Study: Bioelectricity bests biofuels on miles per acre"
- ↑ CNET: "Study: Bioelectricity bests biofuels on miles per acre"
- ↑ http://seekingalpha.com/article/149477-exxon-s-biofuel-bet?source=email SeekingAlpha: Exxon's Biofuel Bet]
- ↑ Caterpillar 2008 10-k, p. 13.
- ↑ New York Times Article on Obama Stimulus.
- ↑ http://seekingalpha.com/article/86304-caterpillar-inc-q2-2008-earnings-call-transcript?source=feed
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