Caterpillar: The View From The Cab
When James W. Owens took over as chairman and chief executive of Caterpillar Inc. (CAT ) last February, he expected to have a pretty good freshman year. With demand rising around the globe and across Caterpillar's product line, Owens predicted that 2004 profits would surge by 40% from a year earlier, with revenues increasing 12%. Turns out Owens was way off. He's having a fabulous year. Caterpillar is now predicting that earnings will leap by at least 80% this year, to $2 billion or more, with sales up more than 25%, to at least $28.5 billion. And as good as those results promise to be -- both figures would be unprecedented -- Owens says Caterpillar's numbers will be higher in 2005. The consensus analyst forecast is that earnings will rise 20% on a 10% sales increase.
Caterpillar is known, of course, for its giant yellow earth-moving machines. But the Peoria, Ill., manufacturer ranks first or second as well in diesel engines, mobile power generators, and supersize mining equipment. And, fueled by renewed growth at home and by China's continuing building binge, orders for many of these products are pouring in faster than Caterpillar can assemble them.
Staying on top of the roaring demand has been tricky. In the year ended June 30, Caterpillar had to bring in 5,800 more workers, raising its head count 9% from a year earlier, to 72,900 -- and it's still hiring. Even so, the company has had to turn to suppliers more than usual to help fill orders. Overtime and maintenance costs are up, too, as Caterpillar speeds up its production lines. To top it off, a global spike in the demand for steel has led to price hikes of up to 50% from suppliers, and even shortages.
Owens, 58, seems a match for the challenges. He joined Caterpillar as an economist in 1972, a year before completing his PhD in economics at North Carolina State University. After moving around the world with the company, he returned to Peoria in 1993 as chief financial officer. Late last month, he was in Las Vegas at an international mining exposition, where he met with BusinessWeek Senior Correspondent Michael Arndt. An edited transcript of their conversation follows:
The turnaround in the industrial economy seems to have surprised you. Why did it?
The strength of it was surprising. We've had some disruptions associated with material shortages and costs for expedited shipping. Our material costs had been falling steadily. We had global deflation for four or five years. Then all of a sudden, we had this tightening. At the same time, as our capacity ramped up rapidly, we were forced to outsource some of the work in order to get more capacity faster. We had to pay some premium for these components over our in-house costs. But even if it cost us, it was important to get more capacity quickly to preserve our ability to serve our customers.
You've been adding capacity overseas, notably in China, but haven't built a new factory here in years. 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. Premiums, co-pays, and deductibles will do that. But it's a national problem. Increasingly, government policymakers have got to think about U.S. manufacturers competing in a global theater.
Do U.S. manufacturers need a national health-care program to compete?
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 medical services in the world.
The strong dollar has been blamed for weak U.S. exports. Is the dollar still overvalued?
Not vis-à-vis European currencies. It has depreciated substantially from recent highs, and U.S. manufacturing is very, very competitive today in Europe. The overvaluation of the dollar is really with Asian currencies, which are constrained by the Chinese yuan. It would be logical for the Chinese to revalue their currency. I don't think their financial institutions are strong enough to support a free-floating currency. But I believe China could support a 15% to 25% revaluation. The Chinese would still be very competitive. But most important, that would provide an umbrella for the Japanese, Korean, and other Asian currencies to depreciate, and frankly bring about better trade balance in the world economy.
Regardless of who wins the Presidential election, 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 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 is because we are 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 good companies. It's hard to believe we haven't corrected that problem. I hope the next Administration will get that resolved.
And then medical costs in general. There has got to be a collaborative effort to find some ways to make our health-care system much more cost competitive.
In 1999, Caterpillar changed its governance rules so that former CEOs could no longer serve as directors. That may ensure independence, but do you lose out by not having them on the board?
I think it's healthy that CEOs leave the board when they retire. I had lunch with my predecessors, Don Fites and Glen Barton, both within the past couple of weeks. I can go talk to them just about any time I want. 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.
Do you think Corporate America is overburdened by new requirements from Congress and the Securities & Exchange Commission?
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 that we've had to put in place -- with external auditors auditing the internal auditors -- we've added an element of expenses to U.S. manufacturers that our foreign competitors don't have to pay.
You've said that Caterpillar's stock price deserves a higher price-earnings ratio than it has. Why?
In the 16 years prior to 1980, we had a valuation greater than the S&P 500 stock index average. We don't today, even though our compounded rate of return is higher. I think we are a far better company than the average company in the S&P 500. We are a high-tech company. We have a global manufacturing presence. We have terrific services operations that are growing. We are diversified. We have a powerful global brand. 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 is better than the average.