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Investment Overview for Caterpillar (NYSE:CAT)

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Caterpillar, also known as "CAT", designs, manufactures and sells machinery focused on mining, quarry and construction applications. It also manufactures engines and turbines focused on power generation, oil drilling and several industrial applications.

The company also sells financial products in the form of financing options of leases and loans and insurance, primarily to drive sales growth of its products.

The company has been operating for more than 85 years and generated sales and revenues of $63 billion in 2012.

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Below are key drivers of Caterpillar's value that present opportunities for upside or downside to the current Trefis price estimate for Caterpillar:

Resource Industries Market Share: Caterpillar's market share has increased significantly in recent years to 33.5% in 2012 driven primarily by benefits from the Bucyrus acquistion. We currently anticipate the company's market share to decline in the near-term due to suppressed purchase activity from Caterpillar dealers in an attempt to reduce their inventory levels. Thereafter, we anticipate the company's market share to increase slightly over the Trefis forecast period to 31.5% by its end.
If however, the company's market share does not decline much in 2013 and reaches 33.5% by the end of Trefis forecast period then there will be a potential upside of nearly 5% to the ${trefisprice}.

Construction Industries Market Size: The global construction equipment market size, which currently stands at approximately $135 billion, is expected to grow substantially over the Trefis forecast period to nearly $154 billion by its end. However, in case it is unable to achieve the estimated growth rate in the wake of the European debt crises and the slowing Chinese economy and reaches only $140 billion by the end of the Trefis forecast period, then there is a potential downside of 3% to the ${trefisprice}.

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Resource Industries division

Caterpillar’s Resources Industries division has become the most valuable business for the company, post the Bucyrus acquisition in July 2011. This division includes the design, manufacture, marketing and sales of machinery focused at mining, quarry and forestry related applications. The high market share that the company now possesses in the global mining equipment market is a potential opportunity to drive margins higher and establish itself as the largest player in the market for several years to come.

Increasing presence in emerging economies

Caterpillar is continuing to increase its presence in the emerging markets of China, India and Brazil. It not only wants to expand into these markets to expand product sales but also as a manufacturing destination. The high growth markets of these economies present the company a potential opportunity to drive high top line growth for its shareholders.

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Rising world population and prosperity driving demand for energy, resources and infrastructure

The rising world population and prosperity particularly of developing nations such as China and India, are driving demand for energy. This increased demand for energy shall drive growth in demand for engines and turbines used in electric power generation units.
Several developing nations, such as India are increasing their spending on infrastructure and housing to support their rising populations. The increased infrastructure spending shall drive growth in construction equipment sales.

People migration from rural to urban areas increasing

Several countries particularly, developing ones are witnessing large scale migration of people from rural to urban ares, leading to increased infrastructure spending on roads, bridges, buildings etc.
The increase in infrastructure spending shall drive growth in demand for engines used in industrial applications.

Rising demand for iron ore and copper leading to mining industry recovery

A recovery is expected in the mining industry due to rising demand for commodities such as iron ore and copper. This will cause the global demand for mining equipment to increase.

Improving macro economic environment

Real estate and housing prices are rising again as the economy is recovering from the financial crises of 2009. This shall lead to increased housing related construction activity which is driving growth in demand for construction equipment.
Growth in world trade post the financial crises shall lead to growth in demand for cargo vessels and other commercial ocean vessels. This will drive the growth in demand for engines used in marine applications.

Emerging economies of China and India large potential markets

China and India will be leading sources of mining, construction and power related equipment demand. This presents opportunities for several manufacturers including, Caterpillar.

Other developing areas to exhibit above-average growth

Eastern Europe, with extensive mineable resources, is projected to exhibit an above average growth in mining equipment demand along with the developing areas of Asia, the Africa/Mideast region and Latin America, with the mature markets of Western Europe and North America trailing.

Rise in interest rates shall moderate growth of market size

Several developing countries are facing high inflation along side growth. Central banks often resort to raising interest rates to control inflation.
Higher interest rates in turn increase borrowing costs for companies leading to an increase in price of their products. This, dampens demand moderating the growth in market size.

European debt crises

European austerity measures can moderate the increase in demand for machines in the short term.
The European sovereign debt crisis has forced several European nations to adopt severe austerity measures in order to control their debt levels.
The austerity measures shall control spending across sectors such as, infrastructure projects, thus dampening growth in demand for various market sizes.

Trefis Forecast Rationale for Caterpillar's Share of Global Machinery Market

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${forecast} represents the revenues of Caterpillar’s machinery division as a percentage of our estimated Global Machinery Market.

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2007

: ${forecast} decreased in 2007 by 3% and stood at 28.6% because industry revenues increased faster than Caterpillar’s machinery revenues. Caterpillar Machinery division revenues increased by 9% to $28,359 million.

During this period, Bucyrus’s revenues increased by 119% to $ 1,613 million.

In 2007, Caterpillar made significant progress towards its commitment to continue expansion of its business in China. As part of its long-term strategic plan to support manufacturing growth in China, Caterpillar opened new manufacturing operations in Wuxi, China. Further, Caterpillar acquired the assets of Blount International, Inc.'s Forestry Division. The acquisition included manufacturing and other facilities that joined Caterpillar's global facilities that produce and support forestry equipment.
2007 machinery sales were up 9 percent as strong growth outside North America and a full year of Progress Rail more than offset a weak U.S. construction market. Machinery volume was up $1.289 billion. Excluding Progress Rail, machinery volume was up $514 million. Although sales volume increased moderately, the geographic shift in sales was significant. North American machinery sales were down 11 percent; machinery sales outside of North America were up 33 percent.

2008

: In 2008 ${forecast} stayed almost stable because combined revenues of Caterpillar Machinery increased at almost the same rate as the overall market.

Dealers added slightly to reported inventories this year, a contrast to more than a billion-dollar reduction in 2007. Dealers reported higher inventories than a year earlier in both dollars and months of supply. Dealers in all regions reported higher inventories than year-end 2007 in both dollars and months of supply.
The U.S. economy was in recession throughout 2008, which contributed to weaknesses in both construction and quarrying. Coal mining and oil sands development were about the only positives for North America.
The euro-zone entered recession in the second quarter and the United Kingdom in the third quarter. As a result of these recessions, housing construction declined sharply, nonresidential construction weakened and sales volume declined.
Sales improved in the developing regions of Africa/Middle East, CIS, Asia/Pacific and Latin America through the first three quarters of 2008. However, growth slowed sharply in the fourth quarter in response to weakening economies.
In 2008, Caterpillar continued investing in its growth initiatives and completed several acquisitions to cement its position within certain geographical segments, most importantly China, and certain product categories such as within global mining business, etc. The most important initiatives that Caterpillar undertook in 2008 were,

acquisition of the remaining 60 percent equity interest in Shandong Machinery Co. Ltd. (SEM), a leading wheel loader manufacturer in China, and
expansion of its Global Mining business through the acquisition of Lovat Inc. (Lovat), a leading global manufacturer of tunnel boring machines used in the construction of metro, railway, road, sewer, water main, penstock, mine access, high voltage cable and telecommunications tunnels.

2009

: In 2009, ${forecast} decreased by 4.4% because revenues of Caterpillar's Machinery business dropped more than that of the overall market. Caterpillar’s Machinery segment revenue decreased by 43% to $18,148 million. Caterpillar’s decline in revenues in 2009 was the largest single-year percentage decline in sales and revenues since the 1940s.

During the same period, Bucyrus’s revenues increased by 5.8% to $ 2,652 million, in spite of tough economic environment, due to continued demand for commodities.

In response to the on-going recession in 2009, Caterpillar continued executing its “trough” plans, which it commenced implementing in 2008, and taking other actions to deal with the effects of the recession and to reduce costs.
In 2009, dealers reduced new machine inventories $3.3 billion, helping them weather a very difficult year and positioning them for growth as economic conditions improve.
Many countries responded to the recession by adopting various forms of economic stimulus packages, including allocations for infrastructure spending, a positive factor for sales of Caterpillar. However, the economic recovery remained uneven at the end of 2009 and beginning of 2010.
During 2009, Caterpillar continued aiming for growth through new joint ventures, acquisitions & agreements.

Caterpillar and Navistar International Corporation (Navistar) finalized a joint venture transaction resulting in a new company, NC2 Global LLC (NC2) to develop, manufacture, market, distribute and provide product support for on-highway medium- and heavy-duty commercial trucks outside of North America.
Also Caterpillar entered into an agreement to acquire JCS Co. Ltd. (JCS), a subsidiary of Jinsung T.E.C. Co., Ltd., a South Korea-based manufacturer that specializes in producing undercarriage components for earthmoving and other off-road machinery.

2010

: In 2010, ${forecast} increased by 4.8% to 29% because Caterpillar Machinery revenues increased faster than the overall market. In 2010, Caterpillar Machinery revenues increased by 53% to $ 27,767 million.

During the same period, Bucyrus revenues increased by 21% to $ 3,218 million.

Caterpillar Machinery sales volume improved as a result of higher end-user demand and the absence of 2009 dealer inventory reductions. In 2009 dealers reduced inventories about $900 million and in 2010 they added about $100 million. Dealer-reported inventories in months of supply at year-end 2010 were lower than both the end of 2009 and the historical average.
As the global economy continued to improve in 2010, the demand for Caterpillar Machinery increased substantially. In response to increased demand and improving economic conditions, Caterpillar announced plans to increase capacity, expand production and make strategic acquisitions.
Mining

In November 2010, Caterpillar announced that it entered into an agreement to purchase Bucyrus International, Inc. (Bucyrus). Bucyrus designs and manufactures mining equipment for the surface and underground mining industries and provides service for its equipment. The acquisition is part of Caterpillar’s strategy to grow its mining business.
Caterpillar also made additional investments in its mining business relating to capacity expansion for trucks produced in Decatur, Illinois and Chennai, India.

Rail

In August 2010, Caterpillar acquired EMD. This acquisition continued Caterpillar’s strategic plan to grow its presence in the rail industry and enables Caterpillar to provide rail and transit customers with locomotive, engine and emissions solutions, aftermarket product and parts support and a broad line of rail-related services and solutions.
Additionally, Caterpillar acquired FCM Rail Ltd., Inspection Products business from GE Transportation’s Intelligent Control Systems division
Also it established a manufacturing facility in Muncie, Indiana to produce diesel-electric locomotives to cement its position in this market.

Also, Caterpillar entered into several other agreements, alliances, joint ventures and establishing of manufacturing facilities to further its growth in Backhoe and Wheel Loaders, Compact Construction Equipment, Excavators, Components and Distribution and Logistics.

2011

: In 2011, ${forecast} increased by around 4.8% to reach 33.7%. This huge jump was driven by Caterpillar's improved performance in China and North America. While China's demand was driven by a need for resources to continue its growth momentum,North American demand was mainly driven by the replacement needs of various fleet operators.In 2011, Caterpillar Machinery revenues increased by 34% to $ 37,278 million.

After the devastating earthquake that hit Japan in March last year, the country has started the process of rebuilding its infrastructure in the earthquake hit areas. According to construction equipment manufacturer Komatsu, the sale of construction machinery makers has gone up by 32% in Japan in the fourth quarter of 2011. Caterpillar's sales have been buoyed considerably by this factor.
A strong backlog has helped Caterpillar in exceeding its sales target for this year. Caterpillar ended 2010 with a backlog of $18.6B and increased it by 59% last year. The current backlog of Caterpillar stands at a record $29.6B. This strong revenue stream has helped remove the volatility from it's sales and earn a good reputation which converts into further orders.
Caterpillar has successful tapped the demand of resource hungry Asian countries whose economies have been growing at a rapid pace. The company has opened a research facility in Wuxi, China and is constructing an equipment testing ground and a production facility for wheel loaders in the country. Infrastructure spending has been a priority for all these countries, and this has helped Caterpillar grow its sales in the region.
Mining

In November 2010, Caterpillar announced that it entered into an agreement to purchase Bucyrus International, Inc. (Bucyrus). Bucyrus designs and manufactures mining equipment for the surface and underground mining industries and provides service for its equipment. The acquisition is part of Caterpillar’s strategy to grow its mining business. The deal was completed in July, 2011 and Bucyrus contributed about $2.5B to Caterpillar's sales in 2011.

Emerging economies and commodities markets trends will continue, and Caterpillar is poised to exploit the opportunities within mining equipment market with Bucyrus acquisition
- According to the mining review by PriceHouseWatercoopers,a business consultancy, more than $120B of capital expenditure was planned for mining projects in 2011 by the top 40 mining companies. It is believed that more than 75% of the planned expenditure was utilized, thus making it more than double of the 2010 spend. The increased commodities activity is largely due to the demand from emerging economies and increased commodity prices. We expect this trend to continue even more vigorously in the future.
- Coal is still the cheapest and most abundant fossil fuel. The emerging countries will be needing more coal to power their growth, in spite of the pollution concerns.
- Bucyrus has a strong presence and reputation with coal mining companies in China that Caterpillar will be able to utilize to power its own growth.
Caterpillar will be more competitive in the mining machinery market
- Through the Bucyrus acquisition, Caterpillar is in a position to offer the widest range of mining equipment and compete more effectively with other large competitors in this space, such as Joy Global and Komatsu.
- We expect that Caterpillar will be able to exploit the synergies, and will be able to sell Bucyrus products through its extensive global dealer network. This will in effect make Caterpillar a 'one-stop shop' for major mining companies such as Rio Tinto and BHP Billiton.
Caterpillar's vision 2020 to drive growth
- Caterpillar released their second phase of vision 2020 in June 2010, setting forth its plans till 2015, which will focus on key customer-critical areas of quality, production capability and cost.
- It depicts the company’s expectations in the areas of market leadership, products and services, distribution system, supply chain, business model, people, sustainable development and financial performance.
- The updated Vision 2020 sets the stage for the next phase of the company’s leadership and growth strategies in the global industries it serves. The company plans to pursue this goal with an aggressive stance and yet maintain focus on customers, people and shareholders.
- We believe that Caterpillar will be able to achieve higher ${forecast} as it aggressively pursues growth strategies and acquisitions to achieve the financial goals that it has set for itself
Caterpillar's focus upon China to yield returns
- Caterpillar has been focusing upon China, and has set up several joint ventures and alliances. It has also set up R&D centers to serve the local market. China is currently one of the largest markets for machineries, and Caterpillar's focus will help it widen its footprint in China, and consequently increase ${forecast}.
Acquisitions to drive growth of Caterpillar
- Caterpillar has been focusing upon growth through acquisitions. We believe that strategic acquisitions will open the opportunities for Caterpillar within key markets, and help it grow its market share.
Caterpillar to have a strong presence in rail industry
- Recent acquisitions of EMD and FCM Rail Ltd. will help Caterpillar to exploit opportunities with rail industry and will further propel the growth of its market share.
Increasing competition from Chinese machinery manufacturers will limit market share growth in the long term
- Many Chinese machinery manufacturers are becoming increasingly competitive. For example, Sany Heavy recently became the largest hydraulic excavator manufacturer in China. Heavy domestic tax breaks from Chinese government will likely accelerate this trend, leading to Caterpillar's market share growth stagnation in the long-term.

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How Does Trefis Modelling Work?

How do we get the historical numbers for this chart?

Trefis has a team of in-house Analysts who gather historical data from company filings and other verifiable sources. When historicals are available, we explain how we got them at the bottom of the Trefis analysis section below.

Who came up with the Trefis forecast for future years?

The Trefis team of in-house Analysts considers a variety of factors when projecting any forecast. The rationale for our projections is explained in the Trefis analysis section below.

How does my dragging the trendline on the chart impact the stock price?

We use forecasts for business drivers to calculate forecasted Revenues and Profits for each division of the company.
We then use forecasted Profits in a Discounted Cash Flow (DCF) model to obtain the Price Estimate for the company.

DCF Methodology

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