On a sequential basis, Caterpillar Inc.’s (CAT) EPS more than doubled to $1.09 in the second quarter ended June 30, 2010 from 50 cents in the first quarter, marking one of the most stellar increases in the company’s history.
The company outstripped the Zacks Consensus estimate by 24 cents and was up 82% from 60 cents in the year-ago period. The outperformance was driven by improved demand across all regions, particularly in developing economies.
Revenues in the quarter were $10.4 billion, a 31% jump from $8 billion in the year-ago period and well above the Zacks Consensus Estimate of $9.8 billion. Region wise, Latin America led with a growth of 83%, followed by Asia-Pacific, North America and EAME markets posting growth of 45%, 24% and 8%, respectively.
As a percentage of revenue, cost of goods sold declined 130 basis points to 70.8% and selling, general and administrative expenses decreased 129 basis points to 10%. Consequently, gross margin increased 130 basis points to 29.2% and operating margin expanded 270 basis points to 14.7% in the quarter.
During the quarter, the company made significant expansion and acquisition announcements. In a bid to expand its rail business from service into engine manufacturing, Caterpillar entered into an agreement to purchase Electro-Motive Diesel for $820 million in cash bringing its total investment in the sector to $2 billion.
The company, in tune with its strategy of international expansion — particularly in emerging markets — announced plans to build a new facility in Brazil and expand its excavator facility in Xuzhou, China. Caterpillar is eyeing emerging markets, particularly China, India and Brazil, in the belief that these markets will help meet its long-term goals.
In addition, Caterpillar announced a new excavator facility to increase production capacity in the United States. The company also has a $700 million multi-year investment up its sleeve to launch a line of mining shovels.
Segment Performance
Machinery sales surged 55% to $6.7 billion due to an increase in sales volumes across all regions and better price realization. The segment posted an operating profit of $477 million in stark contrast to a loss of $252 million in the year-ago quarter. Higher sales volume, lower manufacturing costs and improved price realization, were partially offset by higher selling general and administrative expenses and research and development expenses.
Engines sales increased 3% to $3 billion helped by improves sales volume, increased price realization which was offset by negative currency translation impact. The segment’s operating profit declined 28% year over year to $92 million. Higher selling general and administrative expenses and research and development and lower sales volume, were partially offset by lower manufacturing costs and improved price realization.
Financial Products revenues dipped 5% to $686 million due to a decrease in average earning assets, partially offset by an increase of $14 million due to the favorable impact of higher interest rates on new and existing finance receivables.
Financial Position
Caterpillar had cash and cash equivalents of $3.6 billion as of June 30, 2010, up from $3.5 billion as of March 31, 2010.
The company generated net cash from operating activities of $1.2 billion from operating activities in second-quarter of fiscal 2010 compared with $1.9 billion in the year-ago period.
Machinery and Engines debt-to-capital ratio reduced to 41.9% as of June 30, 2010, compared with 45.2% as of March 31, 2010 and 53.1% as of June 30, 2009.
Outlook
Caterpillar hiked the lower end of its fiscal 2010 revenue guidance by a billion. The current guidance range now stands in the range of $39 to $42 billion, compared with its previous guidance of $38 to $42 billion, which was previously announced on its first quarter fiscal 2010 earnings call on April 26, 2010. Economic improvement in the developing economies of Asia/Pacific and Latin America, improving construction spending and end-user demand for machinery in America, strong mining-related order activity, positive price realization to the tune of 1% led to the new outlook.
The company expects continued strong growth from developing economies with overall growth of over 7%. Caterpillar forecasts a growth of 4.5% in Latin America, 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.
The EPS outlook was considerably increased to a range of $3.15 to $3.85 from the prior guidance range of $2.50 to $3.25. The elevated guidance reflects heightened revenue expectations, margin expansion given the company’s cost cutting efforts, favorable material costs and the absence of redundancy costs. However, these positives will be offset by unfavorable product mix, higher income taxes, increased research and development expenses, pension expenses and incentive compensation.
As the above-mentioned Electro-Motive Diesel acquisition has not yet closed, Caterpillar’s outlook does not embed any revenues or profit impact from this acquisition.
Our Take
We appreciate Caterpillar’s expansion plans in the emerging markets. The emerging markets are showing an improvement as is evident from Caterpillar’s performance in these regions. We expect robust growth in the Asia-Pacific region and Latin America, and continued improvement in the mining and energy markets to further 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 a later-than-expected economic recovery in developed nations, the impact of an unfavorable product mix and higher taxes and pension expenses on the company’s earnings. We thus maintain our long-term Neutral rating on Caterpillar.
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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