Why CAT Reported Better Earnings than Expected

It is interesting to observe the excitement the street has with Caterpillar's (CAT) earnings (see conference call transcript). They were better than company thought last quarter, but sales were still down 41%. I have to give CAT credit for cutting costs as much as they did. But here is what caught my attention in the quarter: the area that was doing less bad was Asia/Pacific, mainly China. Its sales were down only in the 20% range as opposed to other regions like the US and Europe where sales fell 40-50%.

Here is what management said about China:

Fixed asset investment in May was 38 percent above a year earlier. Our dealers reported significantly higher deliveries of machines in June of this year than a year ago.

So the company is doing less bad as it expected because China is doing well. But we know that all of Chinese growth was driven by government consumption and tremendous liquidity growth. China's largest consumers - the US and Europe - are struggling. Its exports are down 21% in June, while its economy posted almost 8% growth and money supply is up 28.5% in June.

I know I sound like a broken record. Growth that is completely predicated on government spending is not sustainable, even if it is taking place in China. I don't know when and what will cause that growth to seize (we didn't know what would cause housing bubble to bust in the US either, but we knew there was a bubble). But when the growth stops, it could get very ugly and the only bright spot in CAT’s picture will get a lot darker.

Disclosure: No positions

Comments

[whidbey]

You got it right and your analysis is consistent with what we know about the capacity of manufacturing to cut costs. But it is not a long run cut they can maintain. In the future it may find its spleen is missing, having been thrown out to lighten ship.

What then? It is really a measure of desperation, but it can not go on too long. We need some sales - worldwide.

2009 Jul 21 06:13 PM

[Alan Young]

"Growth that is completely predicated on government spending is not sustainable" Really? There are U.S. military contractors that have gotten fat for 50 years or more, just on Pentagon spending. And that's *deficit* spending, meaning the US didn't even have the cash.

Okay, I agree. Spending money you don't have on wars you don't need is not sustainable. But I wouldn't mind having a piece of that 50-year cash flow, anyway.

By contrast, China is a central-economy country (I won't disfigure the term "communist" by applying it to this mishmash of accommodations), with a huge surplus that the government can spend as they see fit. Spending money that you DO have on infrastructure you DO need, in an economy where the government overtly controls most of the cash flows... that's as sustainable as anything private capital has ever produced.

That said, that doesn't mean that it's sustainable for CAT, in particular. China is producing its own trains, cars, etc.; I have no idea why they haven't started producing their own construction equipment. There's no assurance that CAT will retain this market share.

So... I guess I agree with your conclusion, even if you overstated your case.

2009 Jul 21 08:05 PM

[Cat Man]

Alan, China IS producing its own construction equipment - at China facilities/companies wholly owned, or jointly owned, by Caterpillar, Komatsu, Volvo, Deere, Hitatchi and other WW earthmoving and heavy duty diesel engine companies.

These Mfgs are producing construction equipment/engines in China for the domestic Chinese market as well as export WW.

How long will it take China and India economies to become self sustaining, ie their domestic consumption becomming big enough to drive global economy?

I think Caterpillar's global sales/revenues have bottomed out, as costs are in line with current demand, and, WW Dealer inventories have been consummed. Dealers will have to start ordering new machines/engines/parts to fill the existing demand levels. The % drop in Cat sales is partly due to Dealers selling off inventory and not re-ordering from Cat until inventories balance with current demand.

Barring global governmental interference/ignorance/ ineptitude, demand should rebound, and explosive infastructure/energy growth in China and India will help global lead growth for Caterpillar, and all heavy equipment companies. How quickly will their demand return to 2007-8 levels depends on the ability of India and China to continue to grow their domestic economies. Both certainly have cash/natural resources and lots of people who need/want power, water, roads and other infastructure.

Cat Man

2009 Jul 21 09:57 PM

[Mad Hedge Fund Trader]

It's all about china. Another great “tell” stock for me is Caterpillar (CAT). I have never owned CAT in my life, but have always followed the company closely because it speaks volumes about the state of the world economy, and because they used to hand out those neat yellow hats at the analyst meeting. CEO Jim Owens says that only painful job cuts held the decline in earnings to 66% on a 41% fall in revenues, with the emphasis on the word “earnings” in the most severe conditions since the thirties. The news was good enough to take the stock up a whopping 40% in a week. CAT gets 61% of its revenues from abroad. Business in Western Europe and Japan is worse than in the US, and what strength they are seeing is in Asia, with China up 8%. Large customers are seeing a resumption of credit lines, while smaller and medium sized ones are not. Owens sees a turnaround beginning in Q4, and a full scale recovery beginning next year, as the cyclicality of its major customers in construction, mining, and energy kicks in to the upside. Longer term, Owens sees CAT’s future in the ongoing infrastructure build out in the emerging markets. Hey, didn’t FCX just tell us that? Is there a trend going on here?

2009 Jul 22 12:05 AM

[Michael Clark]

Cost savings from 20,000 workers laid-off will also not be sustainable. CEO for CAT says next quarter will result in a loss most likely -- and the business picture is the worst he's seen since 1930. They ONLY LOST $700 million this quarter -- that was the GOOD NEWS. And all the analysts scream: "Buy CAT!" The stock flies up. What kind of scam is this? Well, those 'street experts' holding CAT shares since its top at 80 can use this rally to get some of those losses back.


"...I know I sound like a broken record. Growth that is completely predicated on government spending is not sustainable, even if it is taking place in China."

2009 Jul 30 03:05 AM