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Caterpillar Reports Stellar Quarter

Zacks Equity Research

Caterpillar Inc. (CAT) has reported a record quarter both in terms of earnings per share (EPS) and revenues. In the quarter, EPS was $2.54, a 67% increase from $1.52 in the prior year quarter, far ahead of the Zacks Consensus Estimate of $2.26.

Revenues soared 22% to $17.37 billion in the quarter, outpacing the Zacks Consensus Estimate of $16.97 billion. Volumes were up for both new equipment and aftermarket parts as well as across all geographic regions except China and Europe.

Sales were particularly strong in North America and Asia Pacific. Furthermore, price realization, and the Bucyrus and Motoren-Werke Mannheim Holding GmbH (“MWM”) acquisitions also contributed to the rise.

Cost of sales increased 19% to $12.3 billion in the quarter. Manufacturing costs upped $141 million as a result of higher period costs related to production volume and capacity expansion programs.

Selling, general and administrative (SG&A) expenses increased 21% to $1.54 billion and research and development (R&D) expenses scaled up 8% to $632 million ascribed to higher volume, increased costs to support product programs partially offset by lower incentive compensation expense. However, as a percent of revenues, SG&A and R&D expenses collectively declined 50 basis points in the quarter.

Higher sales volume and improved price realization helped offset the rise in manufacturing costs, SG&A and R&D expenses and were instrumental in driving up the operating profit by 63% to $2.62 billion. Operating margin improved 380 basis points to 15.1% in the quarter.

Segment Results

Machinery and Power System (M&PS) revenues surged 23% to $16.7 billion. Construction Industries     sales improved on the back of higher sales volume across all major equipment product categories. Sales increased in Resource Industries mainly on the back of the Bucyrus acquisition and higher volume, particularly for new equipment.

Power Systems sales increased as a result of improved sales volume and price realization. Machinery and Power System’s operating profit jumped 66% to $2.25 billion from $1.5 billion in the prior-year quarter.

Financial Products’ revenues remained flat at $764 million as the positive impact of higher average earning assets were offset by an unfavorable impact from lower interest rates. Financial Products’ profit increased to $188 million from $172 million in the second quarter of 2011. The increase was attributed to a $24 million due to lower claims experience at Cat Insurance and a $13 million favorable impact from higher average earning assets.

Financial Position

Caterpillar had cash and short-term investments of $5.1 billion as of June 30, 2012, down from $2.8 billion as of March 31, 2012. Total debt-to-capital ratio remained flat at 67% as of June 30, 2012 compared with March 31, 2012. The debt-to-capital ratio at M&PS increased marginally to 40.9% at the end of the reported quarter from 40.5% as of the first quarter end.

Total cash flow from operating activities in the first half of fiscal 2012 was $2 billion compared with $3.3 billion in the prior year quarter. Operating cash flow at M&PS declined to $1.28 billion in the second quarter of 2012 from $2.47 billion in the prior-year quarter as a result of unfavorable changes in working capital.

Expectations for 2012

Caterpillar lowered its upper end of its previous sales guidance range by $2 million. The company now expects sales to be in the range of $68 to $70 billion compared with its prior guidance of $68 to $72 billion.

The company has now factored in weaker economic conditions across most of the globe and approximately 1 billion of negative currency impacts. The company has however upped its EPS expectation from the previous $9.50 to $9.60 due to better operating performance, partially offset by a higher tax rate.

Caterpillar estimates that the world economy would grow about 2.5% in 2012. The U.S. economy is expected to improve in 2012, with growth at a rate more than 2%.  Eurozone economic growth is expected to be negative.  Growth in China is estimated at 8% and Japan at 2%.

Our Take

The guidance for 2012 even though lowered in the reported quarter, if realized, would mark the highest revenues and profit in Caterpillar’s history, even ahead of last year’s ground-breaking results. Caterpillar plans to open new facilities and expand existing operations, particularly in the emerging markets, which will boost its long term potential.

Furthermore, the Bucyrus acquisition has positioned Caterpillar as the leading global mining original equipment manufacturer. However, a recent downward trend in sales growth, margin headwinds, the European debt crisis and a slowing Chinese economy remain concerns.

Peoria, Illinois-based Caterpillar Inc. is the manufacturer of construction and mining equipment, diesel and natural gas engines, and industrial gas turbines. The company is one of the few leading U.S. companies in an industry that competes globally from a principally domestic manufacturing base.

Caterpillar operates two divisions – M&PS and Financial Products. It competes with the likes of CNH Global NV (CNH), Komatsu Ltd.(KMTUY) and VolvoAB (VOLVY). The shares of Caterpillar are currently maintaining a Zacks #3 Rank (Hold) over the short term.

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