Caterpillar Inc. (CAT) delivered an EPS of $1.22 in its third quarter ended September 30, 2010, surging 91% from 64 cents in the year-ago quarter and handily beating the Zacks Consensus Estimate of $1.09.
The outperformance was driven by improved sales across all regions, led by developing economies and the company’s relentless focus on cost-cutting. The bright spot of the quarter was the strength in developed economies, which showed improvement after deep declines witnessed in 2009.
Revenues in the quarter were $11.1 billion, a 53% jump from $7.3 billion in the year-ago period and well above the Zacks Consensus Estimate of $10.4 billion. Region wise, Latin America led with a growth of 95%, followed by North America, Asia-Pacific and EAME markets posting growth rates of 55%, 51% and 31% respectively.
As a percentage of revenue, cost of goods sold declined 240 basis points to 69.6% and selling, general and administrative expenses decreased 210 basis points to 10.3%. Consequently, gross margin increased 240 basis points to 30.4% and operating margin expanded 440 basis points to 15.5% in the quarter.
In a bid to expand its rail business from service into engine manufacturing, during the quarter, Caterpillar closed the acquisition of Electro-Motive Diesel (EMD) for approximately $925 million bringing its total investment in the sector to $2 billion. The acquisition resulted in a $216 million increment to sales in the quarter but had little impact on profit.
Segment Performance
Machinery sales surged 84% to $7.2 billion due to an increase in sales volumes across all regions and better price realization. The segment posted an operating profit of $615 million in stark contrast to a loss of $124 million in the year ago quarter. Higher sales volume and lower manufacturing costs were partially offset by higher selling general and administrative expenses and research and development expenses.
Engines sales increased 21% to $3.2 billion helped by improved sales volume and increased price realization, which was offset by a negative currency translation impact. The segment’s operating profit upped 44% year over year to $531 million. Increased sales volume, lower manufacturing costs were partially offset by higher selling general and administrative expenses and research and development expenses.
Financial Products revenues dipped 5% to $682 million due to a decrease in average earning assets and unfavorable impact of lower interest rates on new and existing finance receivables. The segment’s operating profit inched 4% to $96 million. The increase was driven by a $24 million favorable charge from returned or repossessed equipment and an $8 million decrease in the provision for credit losses at Cat Financial, partially offset by a $17 million unfavorable impact from lower average earning assets and $9 million due to incentive pay.
Financial Position
Caterpillar had cash and cash equivalents of $2.3 billion as of September 30, 2010, up from $3.6 billion as of June 30, 2010. The company generated net cash from operating activities of $1.1 billion from operating activities in the third quarter of fiscal 2010 compared with $1.7 billion in the year-ago quarter.
Machinery and Engines debt-to-capital ratio improved to 39.1% as of September 30, 2010 compared with 49.5% as of June 30, 2010.
2010 Outlook
Caterpillar hiked the lower end of its fiscal 2010 revenue guidance by $2 billion. The current guidance range now stands in the range of $41 to $42 billion compared with its previous guidance of $39 to $42 billion. The increase in guidance was due to the EMD acquisition in the quarter as well as improving volume trends. The mid-point of the range suggests a growth of 28% from 2009 revenue of $32.4 billion.
The EPS outlook was also considerably increased to a range of $3.80 to $4.00 from the prior guidance range of $3.15 to $3.85. The elevated guidance was due to the improvement in sales, the continuing focus on cost management and lower taxes, partially offset by higher provisions for incentive pay. The mid point of the range suggest a 79% growth over 2009 EPS of $2.18 (excluding redundancy costs) and 173% growth over 2009 EPS of $1.43 (including redundancy costs).
The company expects the world economy to grow more than 3.5% in 2010 driven by continued strong growth of 7% from developing economies. Developed economies are expected to grow at slightly more than 2%.Caterpillar forecasts a growth of 5.5% in Latin America and 4.5% growth in Africa/Middle East, and the CIS in 2010. The Asia-Pacific economy should grow by more than 8.5% in 2010 and economic growth in China would average 10.5%, marking the fastest growth since 2007.
Looking Forward into 2011
Caterpillar expects its revenue to approach the $50 billion mark in fiscal 2011. The company expects the world economy to continue its recovery in 2011, with growth exceeding 3.5%. Developing economies are projected to grow at 6.5%. Developed countries are expected to grow at 2.5%, lagging the developing economies.
Demand for engines is also expected to improve, but at a slower rate than machines. The full-year impact of EMD sales is expected to add about $1.0 billion. Emissions-related price increases will begin in 2011 for machines in the United States and Europe. However, price realization, excluding emissions, will be modest and will likely be less than 1%.
Our Take
A strong brand name, pricing power and global dealer network put Caterpillar in a good position to take advantage of the growing need for infrastructure development worldwide. Caterpillar has recently announced investments of roughly $2.5 billion in the United States, Brazil, China and India. These involve opening new facilities, expanding existing operations and developing a new mining shovel product line, as well as acquisitions that will boost long-term potential.
We believe once President Obama’s $50 billion plan to rebuild the U.S infrastructure is approved, Caterpillar will benefit immensely. We currently have a Zacks #1 Rank (short-term Strong Buy recommendation) on the stock.
Peoria, Illinois-based Caterpillar Inc. is the manufacturer of construction and mining equipment, diesel and natural gas engines, and industrial gas turbines. The company is one of the few leading U.S. companies in an industry that competes globally from a principally domestic manufacturing base. The company operates three divisions – Machines, Engines and Financial Products.
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