China concerns trump Caterpillar profit, outlook

Concerns about a slowdown in China and other key emerging markets overshadowed Caterpillar Inc's better-than-expected rise in first-quarter profit, sending its shares down 5 percent during Wednesday's trading session.

Caterpillar continued a string of strong quarterly performances, posting a 29 percent profit increase by relying on its growing mining business and sales to U.S. buyers looking to replace aging equipment. The world's largest maker of construction machinery also increased its profit guidance for the year.

But investors latched on to the company's slowdown in China and Brazil, and continued concern about Europe. This only stoked Wall Street's existing fears about emerging markets during the current earnings season. Doubts about China were coupled with additional concern over the way the company went about lifting its full-year forecast. "The quarter was good, but guidance was only increased by the amount of the beat and revenue guidance was unchanged, "Jefferies & Co equities analyst Stephen Volkmann said in a note to investors. He said the company's growing inventory levels "may raise some investor concerns."

In recent quarters, Caterpillar has been a leading player in a U.S. industrial sector that has shrugged off economic fears by posting record profits and providing an optimistic outlook. While emerging markets have provided an increasing slice of sales growth, an improving U.S. economy is increasingly underpinning the performance of these companies.

 "We just continue to see throughout this quarter that North America continues to be strong for these industrial companies, and that is definitely true for Caterpillar," Jeff Windau, an analyst with Edward Jones, said. Caterpillar has been investing heavily in capacity and is aggressively chasing sales in that market, and it now has too much inventory in the China.

Executives moved to allay concerns by addressing the issue during its first-quarter conference call with analysts. Mike DeWalt, director of Caterpillar investor relations, said the China market -- while important -- does not have a massive impact on bottom line at this point. And the company is convinced China's government has a solid long-term growth plan.

"It's an important market particularly for the future,"

DeWalt said. As for its influence on Caterpillar's results: "It's just not as significant as many people believe."

He also said that pricing is holding up despite concerns that there is too much production capacity in the industry. Still, the company is taking action to mitigate any short-term concerns.

DeWalt said the company has "too many finished goods on the ground." As a result, Caterpillar will divert about 20 percent of its China excavator production to other countries where demand is much stronger for that equipment.

The company also is willing to tweak its growth blueprint for the country. While Caterpillar is not cancelling any of its expansion plans, it could slow the timing of those projects if the need arises, DeWalt said.

'WE REMAIN ON TRACK'

While traditional construction markets are weak, North American customers are scrambling to replace aging machinery, including excavators and bulldozers. This is taking place as construction companies work to keep up with a backlog of expansion projects in the United States and Canada, including are relative boom in the energy sector.

Many of these construction companies did not buy new machinery from 2008 through 2010 due to credit constraints and a lack of business. Now, they are rushing into the market, helping drive Caterpillar's backlog to $30.7 billion, or $10 billion more than it was a year ago.

Another factor driving Caterpillar is growing strength in the mining business, which was bolstered by its 2011 acquisition of Wisconsin-based Bucyrus. The company's power equipment sales, including locomotives and engines needed for gas and oil companies, are also running at a solid clip.

"We remain on track ... at a time when U.S. construction activity remains depressed and economies in Europe, China and Brazil have slowed," Caterpillar Chief Executive Doug Oberhelman said in a press release. The slowing in China and Brazil comes as those countries "took steps in 2011 to slow their economies and bring inflation under control," Oberhelman said.

Brazil and China are expected to ease their policies. "Although it's tough to predict the exact timing, we expect positive economic growth moving forward," Oberhelman said.

The company will need its prediction to hold as it steadily installs and expands global production capacity, leading to a brisk hiring pace and increased costs related to lifting production and headcount. In addition, material costs --including steel prices -- continue to rise.

MARGIN STRENGTH

Analysts were encouraged by the company's incremental profit margins during the quarter, which were robust even as the company only modestly raised prices.

"We thought the quality was good, especially in margins that continue to improve without relying on the pricing lever," Rob Wertheimer, a Vertical Research Partners analyst, said. The company's strategy of lifting profit margins via productivity and cost improvements on the plant floor is paying off, he said.

The strength in North America as emerging markets sag is actually a positive trend for Caterpillar, Morningstar analyst Adam Fleck said. Chinese customers tend to buy a larger percentage of smaller, less-expensive machinery while buyers in established markets more often opt for bigger goods.

Caterpillar reported net earnings of $1.6 billion, or $2.37 per share, compared with $1.2 billion, or $1.84 per share, a year earlier. Caterpillar's sales rose 23 percent to $16 billion during the first quarter, the company said.

Analysts on average had projected a profit of $2.13 a share, according to Thomson Reuters I/B/E/S. Revenue, however, fell short of the $16.2 billion that Wall Street had expected.

The company increased its profit outlook for the year to $9.50 per share from $9.25 previously. The outlook for revenue, however, remained in the range of $68 billion to $70 billion.

Caterpillar's resources segment, which includes mining, delivered a 73 percent increase in revenue and a 46 percent jump in earnings. Construction products reported a 13 percent jump in both sales and profit.

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