Wednesday, January 27, 2010

Caterpillar Inc. (CAT)

Can the Fat CAT Stay Trim This Cycle?
■ Reiterate Outperform. We reiterate Outperform and adjust our TP to $70 (assumes 15x our 2012 EPS of $5.15, discounted back). With 31% potential upside and the stock off 17% from its early-January highs, we think investors should use weakness as an opportunity to get more constructive on the name— particularly given there is likely upside to CAT’s 2010 guidance, in our view.

■ Setting the Bar Low. CAT’s ‘10 EPS guidance of $2.50 was disappointing to investors, as this only implies 15% growth despite a sales forecast of up 10-25%. The lower EPS is driven by unfavorable mix in Machines as well as several headwinds including higher R&D ($0.31), no LIFO benefits ($0.39), higher taxes ($0.95) and an increase in pension expense ($0.18). This is partially offset by flat SG&A and limited factory overhead costs (except D&A). Even so, we think
guidance is conservative as the absence of dealer destocking should fuel significant op. leverage even in the face of the aforementioned headwinds. Importantly, Engine margins should hold at 4Q levels (or better) throughout ‘10. In terms of revs, the low-end of guidance implies demand destruction (sales up $3.2B y/y vs. dealer inventory reductions of $3.9B in ’09). The midpoint assumes revs grow $5.7B ($3.9B Machines and $1.8B from parts, Reman and emerging mkts) with a modest decline in Engines. The top-end assumes U.S. dealers restock more aggressively coupled with an improvement in U.S. coal activity. Finally, revs and EPS should ramp sequentially throughout ‘10.

■4Q09 In-Line. CAT reported 4Q09 EPS of $0.41 (excl. $0.05 in redundancy charges) vs. the street est. of $0.28. Adjusting for a tax benefit, EPS was $0.25. Similar to prior quarters, EPS also included LIFO benefits ($0.09). Sales of $7.9B (down 39%) came in ~$200M below street est.’s, but grew 8% q/q (impressive considering CAT dealers took out ~$800M in inventories in 4Q). Op. margins of 3.0% fell 60bps q/q, though decrementals were solid at 4%.

Consolidated Results

CAT reported EPS of $0.41, ex. $0.05 in redundancy costs, vs. the street estimate of $0.28. A tax credit boosted EPS by $0.16, bringing adjusted EPS to $0.25, which was inline with our estimate, but lower than consensus. It is important to note that there was considerable uncertainty around the correct tax rate for the quarter. Finally, the reported figure included LIFO gains of $0.09. Sales of $7.9B were down 39% y/y, $200M below street expectations. However, q/q revenues increased 8% despite dealer inventory reductions of ~$800M. Operating margin of 3% declined 60bps q/q and decremental margin held at a solid 4%. Equipment gross margin of 18.6% represents an increase of 170 bps y/y. Ex. the LIFO benefit, gross margin was 19.5%, or 260 bps higher y/y. The Machinery segment realized a net operating loss of $123M, while Engines posted an op. profit of 242M, representing an op. margin of 9.2%. Total redundancy costs were $65M, while LIFO benefits totaled $70M. For the year, redundancy costs were $705M, in-line with company guidance.

Machinery Machinery sales declined 41% y/y while posting a loss of $123 million (vs. ~flat in Q408). The segment did realize positive price of 1.1%. Once again impacting machinery sales were dealer inventory liquidations of $700M in the quarter, bringing the 2009 year-end reduction total to $3.3B. The weakest geography in terms of equipment sales declines was the EAME region, down 52%. NA fell 45% and Latin America fell 32%. Sales in Asia-Pac decreased 25%.

Engine segment sales fell 41% y/y w/ broad-based weakness across geographies (LA down 53%, NA down 46%, EAME down 39%, and Asia-Pac down 28%). Dealers reduced engine inventories by $500M in the year. Price helped by $116M. Op. profit of $242M represents a 9.2% margin, down 70 bps y/y and 460 bps q/q. margins were negatively impacted by lower sales volumes for turbines.

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