Caterpillar Inc. (CAT), in tune with its strategy of international expansion — particularly in emerging markets — announced plans to expand its manufacturing presence in Brazil. Caterpillar will build a new facility in Brazil to produce backhoe and small-wheel loaders to cater to the Latin American market.

As of 2009 end, the company had four manufacturing facilities in Brazil: Curitiba, Diadema, Hortolandia and Piracicabas. The company is in the process of finalizing the location of the new facility, and expects to start construction in late 2010 or 2011.

Caterpillar’s existing manufacturing operation in Piracicaba produces wheel loaders, motor graders, backhoe loaders, track-type tractors, excavators, compactors, underground mining loaders, generator sets and a variety of components. Once the new manufacturing facility begins production, it will allow Caterpillar to increase capacity for the other machines produced in Piracicaba.

Caterpillar’s expanded operations will help meet customer demand in Brazil. Demand has been robust due to the strong economic recovery that has taken place across the region last year. In addition, Caterpillar’s existing operations in Brazil have been a consistent leader in the development and implementation of the Caterpillar Production System (“CPS”), earning a reputation for quality and manufacturing excellence within the organization.

This news is in sync with Caterpillar’s announcement to expand its excavator facility in Xuzhou, China on June 28, 2010. Caterpillar reached an agreement with Xuzhou Construction Machinery Group (“XCMG”) to acquire XCMG’s 16% ownership interest in Caterpillar Xuzhou Limited (“CXL”), a joint venture between Caterpillar and XCMG that was initially established in 1995. Pursuant to regulatory approval, CXL will be a wholly owned Caterpillar company. Once the CXL excavator expansion plans are completed in 2014, Caterpillar estimates its China-based excavator capacity will almost quadruple.

Caterpillar is eying emerging markets on the belief that these markets would help meet its long-term goals. China, India, Brazil are all key regions of future growth as they have growing infrastructure markets and emerging economies that will pay premiums for Caterpillar’s equipment.

Asia-Pacific contributed 22% to Caterpillar’s revenues in 2009 and 27% in the first quarter of fiscal 2010. Latin America made up 12% of 2009 revenues and 12% of first quarter’s revenues. In the first quarter of fiscal 2010, Asia-Pacific revenues increased 20% year over year and revenues in the Latin American region remained flat year over year.

On June 18, 2010, Caterpillar reported an 11% year-over-year jump in global sales in May 2010, after a long trend of global decline since September 2008. Higher sales were helped by a strong performance in Asia. Asia-Pacific’s 38% growth in May 2010 was a stark contrast to the 30% decline in the year-ago period and a substantial improvement over 13% growth in April 2010 and 11% in March 2010. Even though Latin American markets posted a 2% decline in May 2010, it was a marked improvement over the double-digit declines the company suffered in these markets in the past year.

The emerging markets are showing an improvement as is evident from Caterpillar’s performance in these regions. The company expects continued strong growth from developing economies with overall growth of over 6%. Caterpillar forecasts 4% growth in Latin America, Africa/Middle East, and the CIS in 2010. The Asia-Pacific economy should grow more than 7.5% in 2010 and economic growth in China would average 10.5%, marking the fastest growth since 2007.

Citing strength in the emerging markets of Asia-Pacific and Latin America, Caterpillar raised its fiscal 2010 guidance range. The company now expects 2010 revenue to be in the range of $38 to $42 billion, up from the previous range of $35.6 to $40.5 billion. The earnings per share guidance range now stands at $2.50–$3.25, up from the previous guidance of $2.50.

We appreciate Caterpillar’s expansion plans in the emerging markets. We believe robust growth in the Asia-Pacific region and Latin America, and continued improvement in the mining and energy markets, will strengthen Caterpillar’s volumes and sales. The company will be a prime beneficiary of increased domestic and international infrastructure spending.

Further, Caterpillar is well positioned to expand margins through its CAT Production System initiatives, ultimate pricing power, market leadership, and exposure to the global infrastructure boom as end markets rebound.

However, these positives will be partially offset by later-than-expected economic recovery in the developed nations, the impact of an unfavorable product mix and higher pension expense on the company’s earnings. We thus maintain our Neutral rating and Zacks #3 Rank on Caterpillar.
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