Caterpillar: Poor Traction in North America

Despite robust growth elsewhere, the company's results have been hurt by factors like the U.S. housing slump

Caterpillar Hurt by Weak U.S. Housing, Trucking

Despite big growth overseas, Caterpillar was hurt by weakness in North American markets and inefficiencies within the huge equipment manufacturer

by Ben Steverman

The company providing equipment to the world's infrastructure boom disappointed Wall Street Friday, sending the Dow index lower. Caterpillar (CAT), the large, global equipment manufacturer, is profiting from a global building boom. But, the firm is weathering slowdowns in key markets in the U.S. and it's trying to repair problems within the company, including supply disruptions and rising costs.

Caterpillar reported earnings of $1.24 per share. That compares to $1.52 in the second quarter a year ago, and $1.48 that analysts were expecting according to Reuters Estimates.

"Spectacular sales growth" overseas helped offset poor sales in North America, chairman and chief executive Jim Owens said in a statement. Revenues, at $11.4 billion, were up 7%, and actually beat analysts' estimates.

In the U.S., Caterpillar suffered along with the very weak U.S. trucking industry. Its on-highway truck sales fell $366 million.

Also, Owens cited "weakness in North American construction markets." The main culprit is undoubtedly the housing market, which is seeing far fewer new homes being built.

Though spending on nonresidential construction is up, new construction starts are down, says Eli Lustgarten of Longbow Research. The beginning and end of major construction projects is usually when Caterpillar equipment is needed, he says.

Problems for Caterpillar extend beyond weak conditions in the U.S., analysts say. "Underneath all this there are some huge inefficiencies in Caterpillar," says Charlie Rentschler, an analyst at Wall Street Access. The firm consistently complains about disruptions in its supply chain from parts suppliers. Inventory issues cut into sales and profits, as Caterpillar dealers reduced their inventory by $800 million in an effort to make its supply chain more efficient.

Caterpillar expects overseas sales to be up 24% this year, but that actually results in lower profit margins. Selling equipment overseas is more expensive because of logistics, shipping costs and currency issues, Lustgarten says. (Even if a weak U.S. dollar ultimately makes Caterpillar's products "much more competitive," he adds.)

Rentschler also complains that the company has a "very archaic, opaque" way of reporting earnings and sales. Managers "deliberately make it impossible for people to understand what's going on," he says. That makes it harder for analysts to make predictions.

There was good news for Caterpillar investors on Friday. Despite its earnings disappointment, the firm reaffirmed its earnings outlook for the full year. It expects profits of $5.30 to $5.80 per share this year, up from $5.17 last year.

And despite the problems, many of the fundamentals look good for Caterpillar.

"This is the decade for industrial products on a global basis," Lustgarten says. As developing countries boom and commodities are in short supply, Caterpillar provides equipment needed to build out the world's infrastructure.

One lesson from Caterpillar's recent earnings? These broader trends won't translate into "straight up" growth for Caterpillar, Lustgarten says. Expect volatility.

Wachovia analyst Andrew Casey warns that Caterpillar is especially "sensitive to downturns in the U.S. and global economies." Expect "volatile performance over the next few months," he wrote in a report Friday.

The stock was down almost 6.5% in mid-afternoon trading. As one of the 30 components of the Dow Industrial Average, Caterpillar helped send that index lower. Still, Caterpillar is up almost 33% for the year.

"It's a juggernaut of a company and I certainly wouldn't bet against them," Rentschler says. He says Caterpillar has great products and design and strong management, which has ambitious goals to improve the firm's efficiency. "They'll probably figure it out," he says.

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