Caterpillar Credit Rating Lowered

S&P says the downgrade reflects concerns about increased exposure to unfunded postretirement benefit liabilities

On June 24, 2003, Standard & Poor's Ratings Services lowered its corporate credit ratings on Caterpillar (CAT ) and its captive finance subsidiary, Caterpillar Financial Services Corp., to 'A' from 'A+' and removed the ratings from CreditWatch where they were listed on April 15, 2003. At the same time, the 'A-1' short-term corporate credit ratings, which were not on CreditWatch, were affirmed. Outstanding consolidated long-term borrowings totaled $16.6 billion at Mar. 31, 2003. The outlook is stable.

The downgrades reflect concerns about increased exposure to unfunded postretirement benefit liabilities, which, including defined benefit pension and retiree medical liabilities, stood at $5.5 billion at year-end 2002. Even considering the potential for a rebound in pension portfolio performance and a rise in interest rates, Caterpillar will need to make large ongoing cash contributions to significantly reduce or eliminate pension exposure, which could reduce financial flexibility somewhat and cause management to adjust the firm's business options.

Ratings reflect Caterpillar Inc.'s strong competitive business position, notwithstanding very challenging business fundamentals. While Caterpillar faces large unfunded postretirement benefit liabilities, it also has satisfactory cash flow protection and should generate acceptable earning measures, even at the bottom of the economic cycle.

Caterpillar is by far the world's largest producer of construction equipment, with roughly twice the global share of its closest competitor, and the world's leading diesel engine manufacturer. The company continues to strengthen its business position through the introduction of new products and by targeting niche markets where it has lower penetration. Management is also focused on cost reduction and productivity improvement. While North American and Western European markets are mature, large infrastructure needs in emerging regions should bolster long-term growth prospects.

Earnings have declined materially since peaking in 1997 at $1.66 billion, reflecting weakness in a number of important end-markets. For 2002, net income of $798 million was down 12% from 2001, before restructuring charges taken in 2001. Earnings for 2003 could be down slightly but then should strengthen starting in 2004 as markets recover and Caterpillar realizes increased cost-reduction benefits from its six-sigma program.

Adjusted for Standard & Poor's captive finance company methodology, credit measures are down materially from the cyclical peak but are still satisfactory. However, credit measures are much weaker when adjusted for underfunded postretirement obligations. At year-end 2002, unfunded pensions obligations stood at about $1.9 billion, and other postretirement employee benefit (OPEB) liabilities totaled about $3.6 billion. Absent a significant rebound in stock market performance and a rise in interest rates, pension funding will consume a meaningful portion of Caterpillar's cash flows for the next few years. Over the intermediate term, Standard & Poor's expects Caterpillar to make sizable cash contributions to its pension plans and to take other steps as appropriate to curb pension and OPEBs exposures.

At year-end 2002, on a captive-adjusted-finance-company basis, debt at Caterpillar's manufacturing operations totaled $3.8 billion and unfounded postretirement benefit liabilities totaled $5.5 billion, for a total of $9.3 billion of debt and debt-like obligations. While debt-like obligations can fluctuate widely because of such factors as cash contributions, portfolio performance, discount rates, and medical inflation, in the future, Caterpillar's debt and debt-like obligations are expected to be no higher than the $10 billion-$12 billion range.

Liquidity: Caterpillar has ample liquidity. At Mar. 31, 2003, it had consolidated cash and short-term investments of $327 million. Bank lines totaled about $5.9 billion, including a $4.6 billion global credit facility, available to both Caterpillar and its captive finance subsidiary, Caterpillar Financial Services Corp., to support commercial paper programs. Outstanding commercial paper totaled about $1.8 billion. Available credit totaled about $3.8 billion. Debt maturities for the next five years at the parent company are modest, and $3.8 billion of 2003 maturities at finance company operations are largely match-funded with receivables. Caterpillar has no rating triggers or contingent obligations that could materially affect liquidity.

Outlook: The outlook is stable. A strong competitive position, good operational efficiencies, and adequate cash flow protection, after large expected cash outlays for postretirement benefit obligations, should result in sufficient financial flexibility to maintain credit quality in periods of economic weakness.

    Before it's here, it's on the Bloomberg Terminal.