Using Caterpillar To Gauge Global Demand Tells A Positive Story

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 |  About: Caterpillar Inc. (CAT), Includes: KMTUY
by: Investment U

By Jason Jenkins

Caterpillar Inc. (NYSE: CAT) has come to terms to buy Hong Kong-listed ERA Mining Machinery in a deal valued at as much as $887 million.

The offer, a 33-percent premium to ERA’s most recent share price, is another bet by Caterpillar that demand for mining equipment and growth in China will stay strong.

ERA is a Chinese maker of coal-mining equipment, specializing in hydraulic roof supports. Formerly known as ERA Holdings Global, it completed a reverse takeover in September 2010 to transform it into a mining machinery maker.

But more importantly, Caterpillar’s move to acquire it could be a strong sign that global demand isn’t weakening, as many pundits are claiming. But we’ll get to that in a minute…

Acquisition Follows Strong Third Quarter

Caterpillar, which manufactures everything from black-and-yellow excavators and harvesters to diesel-electric locomotives, recently reported a stellar quarter. It earned $1.14 billion (or $1.71 per share) in the third quarter – an increase of 44 percent from $792 million, or $1.22 per share, in 2010.

Revenue increased 41 percent to $15.72 billion due to an international demand for machinery. Emerging markets continued to need construction equipment as their economies grow. More mature countries and economies – while experiencing weak growth – needed to replace older equipment.

Resource industries sales, which include mining equipment, more than doubled to $4.6 billion, while construction equipment sales rose 41 percent to $4.9 billion. Power generation sales increased 21 percent to $5.08 billion. The company backlog reached $28.6 billion during the quarter.

The Peoria, Illinois, company said it expects full-year 2011 profit and revenue to be at the top end of its previous outlook range due to strong demand and should see a record year if the company hits its earnings and revenue expectations. Caterpillar said it added 4,800 jobs during the quarter, including 2,000 in the United States. In 2012, the company expects revenue to increase 10 percent to 20 percent above the $58 billion in sales it expects this year.

What it Means for the Global Economy

Higher commodity prices are attracting more investment in mines and fueling demand for mining machinery.

However, of more importance, we need to take notice of Caterpillar’s outlook, as it is not seeing any signs of a major slowdown in the global economy.

Companies like Caterpillar are a good indication of the world’s economic well being because they make earth-moving equipment – and if these types of corporations are strong, then global infrastructure is strong. We did not see this three years ago directly after the crisis.

Caterpillar and the Industrial Equipment Industry

Keep in mind that until recently, Caterpillar was losing market share in China, which accounts for about half of the total world demand for construction equipment, to rivals such as Komatsu Ltd. (OTCPK:KMTUY) of Japan. A year ago, it had seven percent of China’s excavator market, trailing Komatsu’s 15 percent.

Richard Lavin, Caterpillar’s group president in charge of construction equipment, stated in October that the company had to race to catch up because it previously underestimated China’s growth potential and in recent years hasn’t had enough manufacturing capacity there to meet demand.

Strong demand for construction and mining equipment should boost Caterpillar’s revenue through next year, even as the health of global economy remains in doubt. Komatsu should also benefit from this outlook and consider it a good value with a P/E around 10.

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