Caterpillar Inc. (CAT) Earnings Preview: Upside Surprise Expected in Q1

Caterpillar Inc. (NYSE: CAT), the world's largest maker of construction and mining equipment, is expected to report strong first-quarter profit on mining company demands and consumers' need to replace aging equipment.

Caterpillar Inc. (NYSE: CAT) enters the earnings announcement season with strong revenue momentum. The company has averaged year-over-year revenue growth of 42.4 percent over the last four quarters. However, prior strong performance has made comparisons tough for Caterpillar in the first quarter.

With low expectations, we believe earnings could be a positive surprise, Lawrence De Maria, an analyst at Chicago-based William Blair & Co, wrote in an April 16 note to clients.

In the first quarter, the Peoria, Ill.-based company is likely to book a profit of $2.13 a share on revenue of $16.22 billion, based on the average estimate of analysts surveyed by Thomson Reuters. In the same period a year earlier, EPS was $1.84 on $12.95 billion in revenue.

The consensus estimate has risen over the past month, from $2.12, but it's below the estimate of $2.15 from three months ago.

Douglas Oberhelman, Caterpillar's CEO, said during a March 20 interview on CNBC from Beijing that he was pretty happy with Caterpillar's first-quarter performance and optimistic that 2012 will be another record year.

Underpinning Caterpillar's momentum is a record amount of order backlog pending this year.

We're starting the year with a strong order backlog that's almost $30 billion and up 37 percent from the end of 2010, and that's on an apples-to-apples basis excluding our Bucyrus acquisition, Oberhelman said in a company report last month. Some customers will not get trucks they have ordered until as late as 2014.

For the year, Caterpillar raised its guidance for revenue to approximately $70 billion, near $9.25 a share, which is up about $3 billion from the preliminary outlook for 2012 provided in October.

Analysts expect Caterpillar, a bellwether of the global economy, to boost its 2012 profit outlook when it reports first-quarter results Wednesday, even after it has already offered an optimistic view of the year in January.

The company expects the world economy to grow by about 3.3 percent in 2012, which would be better than the 2.8 percent growth experienced in 2011. The U.S. economy should expand at least 3 percent in 2012, with construction spending, which has been depressed for years, to finally show some improvements.

Caterpillar competes with machinery makers such as CNH Global NV (NYSE: CNH), Deere & Co. (NYSE: DE), Joy Global Inc. (NYSE: JOY), Cummins Inc. (NYSE: CMI) and Astec Industries, Inc. (Nasdaq: ASTE)

Replacement Needs

Caterpillar retail sales demonstrated continued strength during February, with machines generating double-digit year-over-year growth for the 22^nd consecutive month, according to the latest data available.

North America construction markets could lead the way, given replacement demand and some uptick in underlying activities, Barclays Capital analyst Andy Kaplowitz predicted in an April 16 note to clients.

Caterpillar said the average age of machines in dealer rental fleets was historically high at year-end 2011, despite an increase in new machine additions during the year. The company expects aged fleets and low fleet inventories will cause dealers to continue to upgrade rental fleets in 2012.

Low interest rates and small improvements in construction spending should encourage replacement demand in North America.

U.S. companies borrowed more to buy equipment in the first quarter of 2012 than a year ago, as they replaced worn-out equipment after deferring such activity during the U.S. economic recession in 2008 and the subsequent sluggish recovery, data released by the Equipment Leasing and Finance Association showed.

Companies signed up for about $17 billion in loans, leases and lines of credit in the first three months of this year, up 17 percent from the year-ago period.

Caterpillar has already started to see some replacement demand of aging fleets, said Morningstar Inc. analyst Adam Fleck.

Foreign Mining Demand

Mining equipment accounts for about 45 percent of Caterpillar's total revenue.

Rapid growth from China, India, Brazil and other emerging markets will push demand over the next decade for coal, copper, iron ore and everything that comes out of the ground, Caterpillar's CEO Oberhelman said during a November 2010 interview after announcing the acquisition of mining equipment maker Bucyrus.

Data from the U.S. Energy Information Administration shows that even though coal is still the largest single fuel used for electricity generation, its share of monthly generation dropped below 40 percent in November and December 2011, the lowest level since 1978.

We've seen coal shipments on rail, for instance, down pretty sharply in the first quarter and some of Bucyrus's businesses may be affected by that, Fleck said, adding that Bucyrus mainly focuses on the U.S. coal market.

Railroad operator CSX Corp. (NSYE: CSX) confirmed the decline in coal shipment during the company's first-quarter earnings release last week. Coal accounts for more than one-fourth of CSX's revenue, and shipment volumes of that were down by 14 percent.

While the U.S. coal market has been beaten down pretty severely as the fuel's dominance of the market continues to be threatened by cheap gas flowing from the shale boom, China's mining market is still expecting growth, Fleck said. China generates 80 percent of its electricity from burning coal.

As the world's largest construction machinery market by sales and the largest consumer of mined commodities, China has continued to show strong, albeit slowing growth, creating huge demand for coal, copper and iron.

The sheer size of the market makes winning in China critical to our goal to be recognized as the leader everywhere we does business, said Richard P. Lavin, Caterpillar's group president for construction industries and growth markets, in a statement.

Despite increasing competition from local rivals like Sany Heavy Industry and Zoomlion Heavy Industry, Caterpillar's market share in China edged up from 5.9 percent in January, to 6.2 percent in February.

Caterpillar is holding on to its market shares [in China] because [local rivals] are competing more heavily in the mid-tier type of products, where Caterpillar excavators are competing with higher-quality type of products, Fleck said.

China's engineering machinery industry is expected to register a growth of about 100 percent by 2015, up from more than $73 billion in 2011 to $145 billion in 2015, driven by government spending on affordable housing and water conservancy projects.

Stock Performance

Bank of America upgraded Caterpillar from Neutral to Buy on April 16, and raised the price target from $127 a share to $134.

Shares of Caterpillar Inc. (NYSE:CAT) gained 1.38 percent, to $108.36 a share in Tuesday's afternoon trading. So far this year, the stock has appreciated 20 percent.