Caterpillar’s Earnings Will Show If U.S. Demand Can Offset China’s Slump

Caterpillar (NYSE:CAT) has scheduled to announce its second quarter earnings on Wednesday, July 25 2012. The company posted good revenue and profit growth in the first quarter, on the back of strong replacement demand in the U.S. mining industry. However, it will be interesting to see if the replacement demand from U.S. is able to offset the decline in demand from slowing economies of China and Brazil in the second quarter. We also anticipate the order backlog to aid top line growth, and higher profits from Caterpillar Financial on account of its reduced exposure to risky assets to aid operating margins in the second quarter.

We currently have a stock price estimate of $111 for the company, approximately 35% above its current market price.

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Strong replacement demand from U.S. driving growth

In the mining industry, customers in the U.S. are looking to upgrade or replace their machinery and equipment. And, in the construction industry, U.S. dealers are building up higher inventories in anticipation of growth. Together the two are driving the top line growth in mining and construction businesses of the company.

Also, the record order backlog totaling nearly $30 billion at the end of 2011 is expected to drive growth over the short-term.

Slowing economies of China and Brazil impacting growth

However, the slowdown of economic growth in China and Brazil, owing to measures taken by their central banks in light of high inflation rates there, is dampening demand for Caterpillar products in these markets. We anticipate the phenomena to impact revenue growth for the company during the second quarter. However, over the long-term as inflation rates ease we anticipate these economies to return to high growth rates leading to a revival in demand for Caterpillar products in these markets.

Higher profits at Caterpillar Financial

Also, Caterpillar Financial, the wholly owned subsidiary of Caterpillar that promotes sale of Caterpillar products by providing financing alternatives has been witnessing higher margins on account of lower credit losses. The subsidiary has been steadily reducing its exposure to risky assets post the financial crises and increasing the proportion of higher quality assets such as, financial receivables and operating leases at constant rates. This has resulted in higher net yield on average earning assets and improved margins for the company. We anticipate the phenomena to aid margins in the second quarter as well.

On the whole, we anticipate Caterpillar’s second quarter earnings to be driven by higher replacement demand for mining equipment and machinery from U.S. and higher profits at Caterpillar Financial, offset by lower demand from slowing economies of China and Brazil.

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