Caterpillar May Need More Muscle

Although Goldman Sachs has issued bullish new projections, the uncertainties of U.S. and global growth make this a tricky bet

By Joseph Weber

Buffeted by labor woes, a rocky global economy, and a sluggish stock market, Caterpillar (CAT ) has been an underachiever for investors for much of this year. After briefly topping $85 a share in January, the global machinery maker's shares briefly drifted below $70 and have been trading in the low $70s recently.

For the analysts at Goldman Sachs, the downdraft looks like a buying opportunity. "Caterpillar's recent underperformance relative to the group is very much overdone," argues Goldman analyst Joanna Shatney and her colleagues in an Aug. 24 report.

Goldman upgraded Caterpillar to outperform from in-line/neutral, citing strong fundamentals and a lackluster performance relative to other companies in the heavy-machinery sector. Perhaps. While no wild cheers were heard, investors sent Caterpillar stock up about 1.5% on the news, with the stock closing at $73.10 on Aug. 24.


  Trouble is, contrarian investors have a truckload of uncertainties to fret about with Cat. Will the global economic recovery continue apace? How much will housing starts ebb in the U.S.? Will the United Auto Workers Union, whose members have twice voted down contracts offered by management -- including as recently as last week -- take to the picket line? Such nettlesome questions sully the outlook for the $23 billion-a-year construction-gear titan and largely explain why investors have been cool to its prospects.

Cat's managers sure have taken a bullish tone. The Peoria (Ill.) company's second-quarter earnings of $552 million -- up from a $399 million gain in last year's second-quarter -- were shy of analyst forecasts, but Cat execs were heartened by a better-than-expected 28% rise in quarterly revenue, to $7.56 billion. And they raised their 2004 outlook, estimating that earnings per share will come in 80% to 85% ahead of last year's, up from a previously expected rise of 65% to 70%.

Sales, Cat said, could be as much as 25% higher than last year. The company expects "to benefit from the best set of economic conditions we have seen in many years," declared new Chief Executive Officer Jim Owens in his quarterly earnings release issued on July 22.


  Still, global and U.S. growth are showing signs of slowing in the second half of this year, and the slowdown could continue through next year. Climbing oil prices and the uncertainties of the Presidential election are already taking a toll domestically. Even Goldman's economists expect a domestic slowdown from a 4.3% projected growth rate this year to just 3% next year. And subdued gains are forecast for Europe, while Asia -- a big expansion market for Cat and other machinery-makers -- keeps driving global gains.

As interest rates in the U.S. creep upward, moreover, they're expected to dampen spirits in the surging housing market. With as much as 20% of Cat's revenues dependent on North American construction spending -– including commercial, highway, and housing work –- dimmed spending there would scale back the outfit's growth potential. And while higher oil prices will help spawn greater demand for mining gear among oil producers, they won't help the other markets the diversified machinery maker serves.

It's unclear, too, whether prices for nickel, copper, and other minerals will keep soaring, driving demand for miners of these goods, as China tries to ratchet back its hell-for-leather growth.

With all the questions marks looming, investors who want to ride with Cat will have to be an optimistic bunch. Plenty of things could delay CEO Owens' campaign to make the heavy-equipment maker a $30 billion-a-year powerhouse. Even the bulls at Goldman don't expect him to hit that milestone until fiscal 2006 -- and plenty can happen between now and then.

Weber is BusinessWeek's Chicago bureau chief

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