Caterpillar: Financial Analysis

Company Overview

Caterpillar Inc. is an American corporation based in Peoria, Illinois. Caterpillar is the biggest manufacturer of construction and mining equipment, diesel engines and industrial gas turbines. The company markets its products directly, as well as through its distribution centers, dealers, and distributors. It was formerly known as Caterpillar Tractor Co. and changed its name to Caterpillar Inc. in 1986. Caterpillar Inc. was founded in 1925 and is headquartered in Peoria, Illinois.

Caterpillar products and components are manufactured in 110 facilities worldwide. 51 plants are located in the United States and 59 overseas plants are located overseas. Caterpillar’s historical manufacturing home is in Peoria, Illinois, which is also the location of Caterpillar’s world headquarters and core research and development activities.

Although Caterpillar has contracted much of its local parts production and warehousing to third parties, Caterpillar still has four major plants in the Peoria area: the Mapleton Foundry, where diesel engine blocks and other large parts are cast; the East Peoria factory, which has assembled Caterpillar tractors for over 70 years; the Mossville engine plant, and the Morton parts facility.

Caterpillar products are distributed to end-users in nearly 200 countries through Caterpillar’s worldwide network of 220 dealers. Caterpillar’s dealers are independently owned and operated businesses with exclusive geographical territories. Dealers provide sales, maintenance and repair services, rental equipment, and parts distribution. Almost 66% of Caterpillar’s sales are made by one of the 63 dealers in the United States, with the remaining 34% sold by one Caterpillar’s 157 overseas dealers. Caterpillar operates through three lines of businesses: Machinery, Engines, and Financial Products.

The Machinery business offers construction, mining, and forestry machinery, including track and wheel tractors, track and wheel loaders, pipe layers, 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, underground mining equipment, tunnel boring equipment, and related parts.

The Engines business provides diesel, heavy fuel, and natural gas reciprocating engines for Caterpillar machinery, electric power generation systems, marine, petroleum, construction, industrial, agricultural, and other applications. It offers industrial turbines and turbine-related services for oil and gas, and power generation applications.

Finally, the Financial Products business provides retail and wholesale financing alternatives for Caterpillar machinery and engines, solar gas turbines, and other equipment and marine vessels, as well as offers loans and various forms of insurance to customers and dealers. It also offers financing for vehicles, power generation facilities, and marine vessels.

Evaluate the company’s vulnerability to current financial threats such as a recession, higher interest rates, and global competition. 

Caterpillar’s situation is very challenging. One of the main problems is the high debt to equity ratio. If a company has a high debt to equity ratio it simply means that they used a lot of outside financing (such as business loans) to finance their company, meaning a lot of the business’s expenses go towards repaying these loans.

Another issue is the slow US housing market. However, the 10-20% revenue increase forecast for 2012 persists in spite of an expected continuation of the weak US housing market and no new highway construction. Also, the falling sales in Africa and the Middle East are caused by the political instability. Caterpillar sales going down about 30% compared with 2010.

Another problem for the construction giant is its poor corporate incentive system. Incentive systems are an important part of any organization. Unfortunately, Caterpillar does not show an organized schemed for employee salaries, bonuses, prizes, etc. With a poor recognition system related to employee incentives, is very difficult to keep talented people.

The increase in raw material costs is causing a limited availability of those materials. Caterpillar Inc.’s raw materials’ spending has increased from 2009 to 2011 in a significant way.

In a global market, the strong competition is a fact. The Japanese competitors are posing a big threat to Caterpillar. Those competitors are Komatsu and Hitachi. Komatsu was especially dangerous to Caterpillar due to the fact that it was the second largest EME (earth moving equipment) Company worldwide. Due to this danger Caterpillar decided to penetrate the Japanese market through a joint venture with Mitsubishi.

The result of this was that Caterpillar and Mitsubishi Heavy Industries Ltd. formed one of the first joint ventures in Japan to include partial U.S. ownership. Caterpillar Mitsubishi Ltd. started production in 1965, has been renamed Shin Caterpillar Mitsubishi Ltd., and is now the No. 2 maker of construction and mining equipment in Japan.

In the other hand, Hitachi Construction Machinery is focusing on mining- equipment, a market that’s less competitive than construction machinery. The company set a target to capture a 30 percent share of the global market for large mining trucks by 2018 to challenge Komatsu and Peoria, Illinois-based Caterpillar Inc. (CAT).

Hitachi Construction Machinery now has a 10 percent share for dump trucks that can carry at least 190 metric tons. It has a 40 percent market share in mining excavators weighing at least 190 tons. Therefore, Caterpillar should increase their participation in the booming Chinese housing market to get a bigger share of business.

Financial Performance

Due to a $76 million favorable impact from higher average earning assets, Caterpillar got an increase in revenues. The Peoria based construction manufacturer reported revenues of $2.645 billion in 2011. That means an increase of $93 million or 4 percent compared with 2010. Also, profit after tax was $378 million, $100 million or 36 percent increase from 2010.

Caterpillar is planning to lay out $3 billion in capital expenditures this year alone to avail itself of growth opportunities it sees all over the world, including laying down the tracks to become over time, the leading builder of construction machinery in China.

Based on current trends and sharply improving prospects, we might expect Caterpillar shares going from $112 to $122. With the company indicating that it expects to consummate the acquisition of small companies in 2012, we believe that Caterpillar can earn $10.00 per share in 2012.

A lot of Caterpillar’s business is still torpid, e.g. Solar turbines, large natural-gas engines, small construction machines related to domestic housing and non-residential construction, etc., and, as these areas start to recover in the next one to two years and Caterpillar folds these small companies acquisitions this summer, we believe that profits can reach $10.00 and shares can fetch $120 in 2012.

New Trends

The success of biofuels may enhance agricultural equipment sales. Caterpillar’s agricultural equipment sector could 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 rapid growth of emerging markets like Mexico, China and India all could benefit Caterpillar, which has distribution networks to offer worldwide industrialization projects with equipment. More than half of Caterpillar’s revenue is international, and that number is increasing. Also, 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. The Real Estate Index Fund (IYR) is down over 30% since July 2008 and is showing no immediate sign of recovery.

Stock Price Analysis

The industrial industry tends to be sensitive to economic cycles. It is better to look for undervalued industrial investments during economic recessions when stock prices are low and sell industrial investments during the late stages of a bull markets when stock prices are high. The global economy is now in a recession; therefore, it is the perfect time to buy industrial investments.

At least for a while, Caterpillar is a stock for holding. This is a stock very likely to improve its performance in the future, but not now. Not even in the short-term. As of today, Caterpillar’s stock price is $110.52.

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One thought on “Caterpillar: Financial Analysis

  1. Thanks for sharing your insights. Hard to find good information on construction equipment in blogs usually, so I am happy to find your website. I agree with you 100%.

    I look forward to reading more in the future and if there is anything I can ever do for you please don’t hesitate to call or email my friend.

    Truly yours,

    Rob
    Stephenson Equipment

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