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By Mike McDermott

A disappointing earnings announcement from Caterpillar Inc. (CAT) this morning is weighing on today’s market.

The near $70 billion dollar construction and mining equipment maker actually beat revenue expectations, but investors are bailing out based on an earnings miss and guidance from management that was somewhat more cautious than what analysts were expecting.

For the quarter, CAT earned $1.72 per share (up 58% over the second quarter last year), on revenue of $14.2 billion (versus $10.4 billion last year). The figures are pro-forma earnings which exclude acquisition expenses for Bucyrus International. Analysts had expected earnings of $1.75 per share from revenue of $13.2 billion.

So with revenue actually above expectations, and earnings coming in so close to analyst projections, why is CAT trading 6% lower?

Today’s weakness is primarily due to management’s cautious comments on the state of the global recovery. Over the past few weeks, investor sentiment has shifted back to “recovery and growth” expectations. Strong earnings from stalwarts like McDonalds Corp. (MCD) and an underlying M&A Bid has helped to reinforce these growth assumptions.

But CAT’s forward guidance hinted at concerns for both the domestic economy in the US – as well as growth in emerging markets. Considering CAT’s broad customer base and global exposure, The CEO’s comments carry significant weight…

Check out a few key quotes from this morning’s earnings release:

“While the economic recovery in the United States continues to be weaker than many expected, we’re forecasting continued moderate economic expansion…

“There’s been quite a bit of concern in the media over the past few months centered on China. While we’ve seen some softening of growth in China, dealer deliveries to end users were up in the second quarter of 2011 compared with the second quarter of last year and grew at a faster rate than the overall industry in China…

“While we expect moderate U.S. economic growth, we believe a lack of confidence in the business climate is the major impediment to a stronger recovery and job creation.”

~Doug Oberhelman, CEO

Even though Oberhelman maintained an optimistic tone when discussing the economic recovery, the risks were evident when reading between the lines. The US continues to face budget deficits, uncertainty over the US debt ceiling, cash-strapped state and local governments, and a businesses who are avoiding expansionary investments because of so much uncertainty.

Across the Atlantic, there is the European debt crisis which translates to austerity measures and less economic / infrastructure growth (key for CAT’s European sales).

And of course the emerging market growth picture is unstable without much transparency. High inflation threatens to choke off China’s growth engine, and local government debt issues (along with ghost cities and dormant construction projects), create plenty of uncertainty for CAT’s Emerging Market division.

Four Corporate Strategy Initiatives

As part of the quarterly earnings release, CAT outlined four overarching themes linked to their corporate strategy:

  • Executing the CAT Business Model – This includes improving quality for existing products, development of new products and solutions, and basically improving value for customers.
  • Increasing Capacity and Production Levels – CAT will be spending about $3 billion this year in capital expenditures to meet rising global demand. CAT has added 27,000 employees over the last 18 months and continues to add jobs.
  • Focus on Costs – Inflation for hard commodities and energy is both a positive and a negative for CAT. Higher prices drive more revenue (from mining and energy companies), but also increase production costs.
  • Integration of Acquisitions – The acquisition of Bucyrus International officially closed on July 8. Any major acquisition carries risks, and it will be key for CAT to demonstrate long-term value from this major purchase.

With cost pressures certainly weighing on profit margins (as evidenced by the revenue beat and EPS miss), management will have to do a good job of both managing these cost pressures as well as communicating with Wall Street to help investors set realistic expectations.

The Effect on Overall Markets

It’s interesting to note the broad market and sector-based reaction to CAT’s earnings. When the company first released its numbers before the open, S&P futures moved from flat to modestly negative. After the open for equities, the market continued to sell off in the first hour before finding support. CAT was blamed for the majority of the weakness, with McDonalds helping to offset index losses.

The effect on base metal miners – as well as competitors Joy Global (JOYG) and Deere & Co. (DE) – was much more muted. This is a bit surprising considering CAT’s relationship with miners – as any growth concerns from CAT would likely be shared by the miners.

The Mercenary Live Feed is currently holding modest short exposure in a handful of base-metal miners as we expect economic growth concerns to weigh on this sector. The risk / reward profile for this area is favorable considering overhead resistance (leading to relatively tight risk points) and plenty of room for these stocks to run if bearish sentiment continues to grow.

Looking at a chart of CAT, the key level for today is the 50 day Exponential Moving Average (EMA) – the brown line on the chart…

If CAT is able to rebound and close above this line, it will be a positive for momentum traders and invite the “buy the dips” crowd to take a shot next week.

However, if CAT is unable to find support in this area, we could begin to see shorts pile into the stock, and the sector could follow suit. JOYG and DE do not report until mid August, so there could be plenty of time before a significant news catalyst could restore confidence.

Disclosure: As active traders, authors may have positions long or short in any securities mentioned. Full disclaimer can be found here.

Source: Caterpillar Lowers the Boom on Markets