News: Analysis & Commentary: EARNINGS
HEAVY EQUIPMENT GETS INTO GEAR
Smarter management helps profits climb despite modest sales
Ah, revenge is sweet. For years, equipment manufacturers were stuck in the shadows while such high-flying sectors as technology basked in the spotlight. Makers of tractors, combines, and other heavy equipment had modest growth prospects, dangerous business cycles, and nagging overcapacity.
But in the second quarter, as tech companies stumbled, heavy manufacturers surprised Wall Street with unexpectedly strong profits. Caterpillar Inc. reported quarterly earnings 16% above the same quarter last year, well above analysts' expectations. Case Corp. announced a 21% surge in operating earnings. And net income at Ingersoll-Rand Co. soared 39%, again handily beating forecasts. With investors fearful of cyclical stocks in a falling market, the share prices of the group haven't done especially well--but they've outperformed the techies. From July 1 through July 23, Standard & Poor's index of diversified machinery makers was off 8.7%, vs. 7.8% for the S&P 500. But the tech-heavy NASDAQ composite index fell a whopping 14.1%.
BRISK EXPORTS. Wall Street jitters aside, strong earnings among the big manufacturers are another sign of the U.S. economy's strength. Cat, which previously expected 1996 sales to decline because of sluggish 1% economic growth, now figures that a 2% to 2.5% expansion will help this year's sales match or exceed 1995 figures. Exports also are brisk--and may get a further boost now as the economies of Mexico, Canada, and European countries start to recover. For instance, Deere & Co.'s exports in the six months that ended April 30 were up 12%, to $723 million. And Deere will benefit from a $187 million combine contract for the Ukraine when it reports fiscal third-quarter results in August.
That doesn't mean that double-digit growth is returning to heavy industry. Unit sales of construction equipment are expected to increase only 3% to 4% annually in coming years and ag equipment sales are in a long-term slide. What's changed is that the manufacturers are doing far better than before at keeping costs under control. Now, with the economy purring along better than expected, profits are soaring. "Rigidity has been common in heavy industry," says Jean-Pierre Rosso, Case's chairman and chief executive. "Now we're finding that we can run the business with fewer assets, lower costs, and a lot more flexibility."
Inventory management has been particularly critical. During boom times, dealers used to stock up until they could cover sales for eight to ten months. When demand sagged, they were forced to unload product at discounted prices. Now, says Robert W. Lane, senior vice-president and chief financial officer at Deere, "We're positioning ourselves to be more disciplined on the downside." Deere and other big manufacturers also are pushing their dealers to keep no more than four months of inventory on hand. And the companies are keeping their own stocks way down, as well. In 1988, for instance, Deere's inventories rose to 17% of goods sold as sales surged. But no more. During 1995, even as revenues soared 14%, inventories stayed at 10% of goods sold.
BRUISING. Labor costs also have been slashed. Deere's workforce of 33,000 is half what it was in 1980. Case is in the midst of a four-year restructuring. And Caterpillar gave its CEO, Donald V. Fites, a 75% pay increase in 1995, to $3.1 million, for aggressive cost-cutting that included winning a bruising battle with the United Auto Workers. Overall, operating margins at equipment makers are expected to jump to about 13% this year, up from 7% five years ago. It doesn't hurt that there is far less competition than there once was. In agricultural equipment, for example, there are just five big players now, including Deere, Case, and Japan's Kubota.
Heavy-equipment makers aren't pretending the hard times are all behind them. One big worry is that the strengthening dollar will cut into export growth, offsetting the positive effects of economic recoveries abroad. Wall Street also worries an economic downturn will hit big manufacturers hard. Indeed, surveys show that the rate of growth in spending on low-tech capital equipment is slowing this year. "This industry has not lost its cyclicality," says Deere's Lane. That's for sure. But as recent earnings reports show, the companies are much better managed now--in good times and bad.By Peter Elstrom in ChicagoReturn to top