Caterpillar Tops Expectations

Caterpillar Inc. (CAT) reported third quarter earnings of 64 cents per share, well above the Zacks Consensus Estimate of 7 cents per share. The company’s better-than-expected performance was primarily driven by higher price realization, lower SG&A and R&D costs, and inventory decrement benefits.

However, on a year-over-year basis the company’s EPS declined 54.0%. Revenue in the quarter was down 43.8% to $7.3 billion from $13.0 billion posted last year. The sales decline in the quarter constituted lower machinery sales volume (-$4.2 billion), lower Engines sales volume (-$1.5 billion), negative impact of foreign currency translation (-$138 million), lower financial products revenue (-$118 million), partially offset by higher price realization (+$227 million).

The company witnessed revenue weakness across its end markets. The Machinery Group revenue was down 52%, while the Engines segment and Financial Products segment have reported revenue declines of 35% and 14% respectively. This was due to a combination of slower residential and commercial construction activity, and a reduction in dealer orders, and tight lending conditions.

The company’s sales were adversely impacted by significant reductions in dealer inventory ($2.6 billion year-to-date). The company forecasts a total of $3 to $3.5 billion reduction in dealer inventories by year-end.

In response to the challenging global business environment, Caterpillar has implemented aggressive cost-cutting initiatives. The company has reduced its workforce significantly. Also, the company has implemented full or partial shutdowns at some of the plants, delayed its R&D programs, and reduced capital expenditure substantially. These actions helped the company achieve its target of reducing SG&A and R&D costs by more than 15%.

Moreover, the company has cut down its inventory by about $2 billion since the end of 2008 with the help of the Caterpillar Production System (CPS). The company expects continued reduction for the remainder of the year. Inventory management is a key element of the CPS.

Caterpillar has updated its full-year outlook. The company now expects 2009 revenue in the range of $32-$33 billion. Earnings for the year are forecasted between $1.85 and $2.05 per share, excluding redundancy costs of 75 cents. The previous guidance was earnings of $1.15-$2.25, on revenues of $32-$36 billion.

The company anticipates an improvement in its top-line in 2010. Caterpillar forecasts a 10% to 25% increase in sales for 2010, compared to the midpoint of the 2009 outlook range. Asserting its optimistic outlook for the coming year, the company recently announced its plans to increase prices by up to 2% worldwide on most of its machinery effective January 2010.

Although we see a continued challenging backdrop for Caterpillar for the next couple of quarters, we expect the company to capitalize on economic recovery. Being a market leader in construction and mining equipment, we believe Caterpillar will benefit immensely from the need for basic infrastructure in both the developing and developed nations.

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