Caterpillar's Growth: Far from Crawling

With sales red-hot, especially abroad, CEO James Owens feels its strong position isn't adequately reflected in its stock valuation

When James W. Owens took over as chairman and chief executive of Caterpillar (CAT ) last February, he thought he would have a pretty good freshman year. With demand rising around the globe and across Caterpillar's product line, Owens figured 2004 profits would be up 40% from a year earlier, with revenue increasing 12%.

Turns out Owens was way off. He's having a fabulous year. Net income will leap at least 80%, to $2 billion, he now estimates, with sales up more than 25%, to $28.5 billion or better.

As good as those results are -- this year's earnings and revenues both will be record highs -- he says Caterpillar's numbers will be even higher in 2005. Known for its giant earth-moving machines, the Peoria (Ill.) manufacturer is much more than big yellow bulldozers. Worldwide, Caterpillar ranks first or second as well in diesel engines, mobile power generators, and supersize mining equipment. And orders for many of these products are pouring in faster than Caterpillar can assemble them.


 Indeed, Owens' biggest problem has been dealing with this upsurge. Caterpillar has had to turn increasingly to outside shops for components, even though they typically cost more. Moreover, it has had to spend more on overtime and maintenance as it speeds up its production lines. To top it off, a global spike in demand for steel has led to price hikes of up to 50% and even shortages.

These expenses have cut into Caterpillar's earnings, Owens concedes. But the manufacturer isn't the only one picking up the tab. Caterpillar has raised prices this year and will again on Jan. 1.

Investors seem cautious. Caterpillar's share price peaked last January and is down 3% for the year, closing at $80.60 on Oct. 1. Its price-earnings ratio is 18.5, while the average ratio of the 500 companies in the Standard & Poor's index -- to which Caterpillar belongs -- is 20.4. But if things break its way, analysts say, earnings should rise 20% or more on a 10% sales increase -- a pretty good sophomore year.

Owens, 58, hired on at Caterpillar as an economist in 1972, a year before completing his PhD in economics from North Carolina State University. He moved around the company and returned to Peoria in 1993 as chief financial officer. In late September, he was in Las Vegas at an international mining exposition, where he sat down with BusinessWeek Senior Correspondent Michael Arndt. Edited excerpts of their conversation follow:

Q: Caterpillar hasn't built a new factory in the U.S. in years, while you've been adding capacity overseas, notably in China. Is manufacturing in the U.S. becoming too hard?


It's challenging, and one of the biggest challenges is spiraling health-care costs. Old, traditional manufacturers like us have carried a lot of that burden for our employees. We have to put more individual responsibility in making wise health-care choices. That's why we're looking for cost-sharing from our hourly workers.

But it's a national problem. Increasingly, government policymakers have got to think about U.S. manufacturers competing in a global theater.

Q: So do you think U.S. manufacturing needs some national health-care program to take that burden off employers?


I'm not a big advocate of that. A lot of Canadians and others come here for health care because we have some of the best health-care services in the world.

Q: As Caterpillar grows overseas, do you see a point when you may not be a net exporter any longer?


I see our sales growth coming substantially from outside the U.S. I also see us investing in more manufacturing capacity outside the U.S. But I would expect we will be a net exporter for years to come.

Q: Regardless of who wins the Presidential election in November, what are you looking for from Washington next year?


Certainly continued pursuit of a global free-trade environment. We'd like to see trade negotiations [started in 2001] under the Doha Round go forward. Free and fair trade has been a great strength of our country. Sometimes we Americans forget that our economy is actually performing better than any of the other industrialized economies in the world. And part of that's because we're honed by having to compete.

We've also got to deal with our tax structure and how it impacts global competitiveness of U.S. firms. Tort reform is very important. Asbestos litigation has bankrupted a lot of very good companies. It's hard to believe we haven't corrected that problem. I hope the next Administration will [move] on tort reform and get it resolved.

And there's got to be a collaborative effort to find some ways to make our health-care system more cost-competitive. We've got to look at how our foreign competition gets subsidized for that burden.

Q: Speaking of taxes, the break for capital investments expires at the end of this year. Is that driving up orders today?


It's absolutely happening.

Q: Might that also be siphoning away orders from next year?


We thought that might happen at yearend 2003, and it didn't. When the economy slows, it will. But our dealers continue to be uniformly optimistic about next year.

Q: In 1999, well before corporate governance became a big issue, Caterpillar changed its governance provisions so that former CEOs could no longer stay on as directors. That may ensure independence, but do you lose out by not having them on the board any more?


I think it's healthy that CEOs leave the board when they retire. I had lunch with [each of] my predecessors, Don Fites and Glenn Barton, within the last couple weeks. I can go talk to them just about any time I want. But I don't think it's good for them to be on the board. I value their advice. I learned a lot from both of them. But when a new CEO comes in, he needs to have the opportunity to make changes.

Q: Another corporate-governance question: Do you think Corporate America is overburdened by new requirements from Congress, the SEC, and the stock exchanges?


I don't want to sound like a moaner, but yes. Sarbanes-Oxley, in particular, is driving a huge amount of cost. Some of it is constructive, but I think it's overkill. People who break the law ought to go to jail.

But the amount of controls we've had to put in place, the redundancy of audits -- with external auditors auditing the internal auditors -- we've added an element of cost to U.S. manufacturers that our foreign competitors don't have to pay.

Q: You've expressed frustration with Caterpillar's stock price. You've said the stock deserves a higher p-e ratio than it has. Why?


We're a high-tech company. We have global manufacturing presence. We have terrific services operations that are growing. We're diversified. We have a powerful global brand. In the 16 years prior to 1980, we had a valuation greater than the S&P 500 average. We don't today, even though our compounded rate of return is higher today.

I think we're a far better company than the average company in the S&P 500. In fact, I can't think of a company that's better positioned to win in the global economy. I'm not asking for much, just a valuation that's better than the average.

Q: Is there a business book you're recommending these days?


I'm a big fan of Jim Collins and his book Good to Great. Caterpillar is a not great company, but we aspire to be.

Edited by Patricia O'Connell