Highlights From CAT's Q3 Conference Call: Mixed Segment Result, Sees Positive Related to Dealer Inventories Over Next 3 Years

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October 20, 2009 3:27 PM EDT

Caterpillar Inc. (NYSE: CAT) reports Q3 EPS of $0.64, versus the analyst estimate of $0.06. Revenue for the quarter was $7.298 billion, which compares to the estimate of $7.49 billion. Shares are up 3.44% today.

Highlights From CAT's Q3 Conference Call:

Sees FY10 sales up 10-25%.
Sales and revenues are expected to be between 32 and $33 billion for the year and profit between $1.10 and $1.30 per share, including about $0.75 per share of employee redundancy costs. (Sees FY09 Adj-EPS of $1.85-$2.05, versus the consensus of $1.49 and $33.07B in revenues)
(IR) End-user demand was weak, dealers reduced their new machine inventories by about 1.1 billion during the quarter and engine sales declined as well.
Sales and revenues were 7.3 billion for the quarter, a 44% decline from Q3 of 2008.
Q3 profit was $0.64 a share and that was down $0.75 from the third quarter of 2008. There were no employee redundancy costs in the quarter, but we do expect more in Q4.
Now I'll go into a little bit more detail on the 5.7 billion decline in the top line. Machinery volume was down 4.5 billion, excluding the impact of Caterpillar Japan.
Worldwide, dealer machine sales were about half of the 2008 third quarter level. Over the past year, we've seen an extraordinarily steep drop in demand in the industries we serve.
And to put that in perspective, in the United States, sales to end users are down about 80% from the peak, which was in the first quarter of 2006 and is well below the historic trend line. In addition, the impact of dealer inventory changes had a very sizable impact on the change in our quarter-over-quarter machinery sales.
During last year's Q3, dealers increased inventory about 100 million. That means that dealer inventory changes had a negative impact on our quarter-to-quarter sales of about 1.2 billion.
Turning to engines, very weak demand also had a significant negative impact on engine volume, which was down 1.5 billion from the third quarter last year and dealers also reduced engine inventories in the quarter.
Financial products revenues were off 118 million and currency had a negative impact on sales of 138 million as a result of a stronger dollar compared with Q3 of 2008.
On the positive side for sales and revenues, price realization was favorable, 227 million or about 3% and the consolidation of Cat Japan added another 280 million. You'll see in this morning's financial release that, in total, machinery sales were down 52% in the quarter and engines sales were off 35%.
One final point about sales and it's about dealer machine inventory; there is no doubt that the significant reduction in dealer inventories had a substantial negative impact on our sales. But as painful as that has been, the good news is that we're well down the path to getting it behind us. That's not to say that it is over. In fact, we continue - we expect more in Q4.
So far this year, dealers have taken out about 2.6 billion and we expect that could grow to between 3 and 3.5 billion by year-end. To put that in some perspective, 3.5 billion drop would mean that dealer machine inventories at the end of this year would be about half of the level at the end of 2008.
Combined, we reduced SG&A and R&D costs 362 million in the quarter. Our manufacturing costs were favorable, 284 million and that included LIFO inventory decrement benefits of 120 million. Excluding the LIFO impact, manufacturing costs were favorable, 164 million.
Price realization was also positive for profit in the quarter at 227 million. Taxes in the quarter were also significantly favorable and 129 million related to prior year tax returns.
Our decremental operating margin rate versus Q3 of last year for machinery and engines was 15%. If you exclude the LIFO decrement benefit, it would have been about 17%.
Some of the key points relative to liquidity and cash flow were machinery and engines' operating cash flow was positive, about 900 million in the quarter. Inventory continued to decline and is down 2 billion year-to-date. Pension-related funding for 2009 has largely been completed.
Cat Financial had about 5 billion of long-term debt maturing in 2009. And so far this year, Cat Financial has issued about 3 billion in three, five, and 10-year notes, 700 million of retail notes, 650 million in medium-term euro notes, 500 million of Canadian dollar medium-term notes.
In terms of Cat Financial's asset portfolio, 30-day past-dues were 5.79% at the end of Q3, that's up 26 basis points from 5.53 at the end of Q2 and that's up from 3.64% at the end of Q3 last year.
Credit loss net of recoveries was 65 million in the quarter. That is 10 million higher than Q2 and 43 million higher than Q3 last year. During the third quarter, Cat Financial increased the allowance for credit loss an additional seven basis points to 1.62% of net finance receivables. That is up from 1.55% at the end of Q2 and 1.44% at year-end.
In terms of profit, financial products' profit before tax was 96 million in the quarter. That is down 75 million from Q3 last year. Since last quarter, our full-year 2009 profit expectation for financial products has improved slightly.
We provided a preliminary outlook for next year's sales and revenues and for 2010, we expect sales and revenues to be up 10 to 25% from the midpoint of our 2009 outlook. We expect that developing economies will help lead recovery and expect world economic growth of about 3% for 2010.
We're forecasting growth in the developing economies collectively of more than 5% in 2010 and growth of about 2% in the developed economies; a little more than that in the U.S., but lower growth in Europe and Japan.
While we are increasingly positive on the prospects for economic growth in 2010, there are certainly risks. Economies likely will remain fragile well into 2010 and a renewed downturn would result in an even worse recession than the one just ended.
In terms of our outlook for 2010 sales and revenues, a significant positive for next year is related to dealer inventories. This year, that's 2009; our dealers are likely to reduce new machine inventories 3 to $3.5 billion.
Absence of 2009's dealer inventory reduction by itself would improve our total topline by about 10% all else being equal.
(Q&A) I'm hoping that you can lay out the scenarios that are underlying the low end and the high end of your expectations. So in terms of a 10%, what are you looking for in terms of housing starts, global GDP growth and then what's implied at the high end of the range as well, please? (A)We think relatively flat retail business, meaning our dealer sales at the low end would -- the absence of the inventory correction we're experiencing this year would yield something in the $35 billion, $36 billion range. That would be the low end of our expectations. Our economist team with about a 3% increase in global GDP, most of the strength of that growth coming in the emerging markets of the world. These -- our industry opportunity, up about 15% and with that and some market share gain that we think we're well-positioned for, we could see that higher end of the up 25%.
So the 3% is basically implied at the midpoint. And then what's your vision for what would get you to the 25% growth rate? I mean is that predominantly a share gain? Is that greater investment in oil and gas and mining in some of those end markets? I mean maybe if you can calibrate the expectations there. (A)Strength in commodity markets driven by reasonably robust growth in the emerging market theaters, particularly Asia, most of South America and Middle East. And those economies in the emergent middle class in those economies driving relatively high demand for commodities, we think could get us to the higher end of our range. Quite frankly, there is more uncertainty in sort of then topline than we are accustomed to. Keep in mind, there is $3.5 trillion worth of fiscal stimulus afloat in the world economy, pretty aggressive monetary policy, pro-growth and coming out of the steepest recession since the '30s. So it is going to be a very interesting year and ne that we are trying to position our management team to respond to aggressively on both the upside, as well as, of course, the downside contingency that retail sales don't improve much. And even in that case, we think we will be up about 10%.
A question I wanted to ask you, Jim, is the release, of course -- and you have made comments on the call about being ready to rapidly ramp up production in response to a cyclical improvement in demand. I think most people would argue that, in this correction that we have seen, companies have been very aggressive, very quick to cut costs in capacity and right-size their businesses because of increased risk. And at the same time, you and others have identified reduced availability and higher cost credit as a specific penalty for smaller companies. So how can you address the supply chain's ability to rapidly ramp up this time when the supply chain was a big part of the problem you experienced in this past upturn? (A)Let me touch on two things. One, thepro-cyclicality of the inventory cycle in this particular business cycle I think has been particularly acute. Not only we, but companies across the industrialized world have been very responsive. The volume dropped so quickly after the fourth quarter collapse of the credit markets a year ago that companies have been scrambling to take employment down and take inventories out. So we have been -- in fact, we have got a road show starting now with our Vice President for Purchasing, one of our group Presidents to help our suppliers understand the magnitude of that impact on them just as business stabilizes next year and once we have got the inventory correction behind us. We think with a very modest increase in sales that the likely requirements on our supply chain is 70 to 80%. It is a staggering number I know, but do the math on some of this inventory swing and you'll get there. That is the kind of increase we are looking for from them. We know they have the capacity for it because we had good capacity utilization in the latter half of 2008. So like us, they have gone to layoffs -- rolling layoffs and we have to get that capacity prepared to come back. And we know it is a very tall challenge. Again, we have had a project Ed Rapp and our treasury group have headed up this year on -- very much focused on cash flow, liquidity getting inventory out. Now we are simultaneously -- we're going to walk and chew gum here together -- working on a project to be ready to power up and that means bring our suppliers back online, be sure we have got good material availability, leverage the great work that has been going on across our factories with the Cat production system to get very good pull-through on the volume side on the way up.