Caterpillar Inc. Goes Far Beyond China
Submitted by Investing Daily as part of our contributors program.
November 25, 2010, was a big day for Caterpillar Inc. (NYSE: CAT). That’s when the world’s leading heavy equipment maker announced the largest acquisition in its history: an $8.8-billion, all-cash purchase of mining equipment supplier Bucyrus International.
Bucyrus Made Caterpillar Inc. a Top Mining Equipment Supplier
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Bucyrus gets almost all of its revenue from the mining industry. It makes a wide range of heavy equipment, from powerful electric shovels to draglines, which pull a large bucket that contains overburden, or dirt and debris that covers coal and other resources near the surface. Draglines are massive (they can weigh up to 8,000 tons) and expensive: they can cost up to $200 million each.
Caterpillar Inc. shares rallied on the news. However, the purchase price amounted to a 32% premium on Bucyrus’s closing price the day before the deal was announced. That had many wondering if Caterpillar had overpaid.
Aftermarket Parts Give Caterpillar Inc. Steady Revenue
Energy Strategist editor Elliott Gue wasn’t among that group. He thought Bucyrus was in a great position to profit from a global mining rebound. But in his view, what many were overlooking was the company’s built-in lead in supplying aftermarket parts. In “M&A Boom: The Next Takeover Targets in the Energy Sector,” he wrote:
“Consider that a dragline has an operating life of at least 40 years. Meanwhile, most of Bucyrus’s underground mining equipment has a useful life of 5 to 15 years. That means that when Bucyrus sells a new piece of equipment, it’s also likely locking in a stream of revenue from service and parts contracts that can last for decades.”
Better still, wrote Gue, the aftermarket business is as close to recession-proof as you can get. When commodity prices dropped during the recession, many miners cut back on big equipment purchases. But they still had to keep their existing gear in good working order, which requires regular servicing and replacement parts.
Bucyrus Helped Power Caterpillar Inc. to Record Profits
Strong demand for Bucyrus’s equipment and replacement parts were important factors in the record earnings Caterpillar Inc. reported yesterday.
In the first quarter of 2012, Caterpillar’s profits jumped 29%, to a record $1.59 billion, or $2.37 a share, from $1.23 billion, or $1.84 a share, a year earlier. Sales rose 23%, to $15.98 billion from $12.95 billion, with Bucyrus contributing $1.0 billion to that total. Mining equipment sales shot up 73%; sales of construction equipment rose 13%.
The latest earnings beat the Street’s expectation of $2.13 a share, though revenue was just shy of the consensus estimate of $16.1 billion.
The strong results prompted the company to raise its earnings forecast for all of 2012 to $9.50 a share, up from its previous estimate of $9.25.
Caterpillar Inc. Chairman and Chief Executive Officer Doug Oberhelman said, “We’re seeing strong global demand for most mining products and significant growth in replacement demand for products in the United States, which more than offset slowing in China and Brazil,”
Despite the strong performance, many investors keyed in on the weakness in emerging markets. That’s why the stock fell 4.6% on the day, closing at $103.44.
Shift Back to North America Is Actually a Plus for Caterpillar
Mike DeWalt, director of Caterpillar investor relations, sought to downplay the lower sales in China: “It’s an important market, particularly for the future,” he said in the earnings call transcript. “It’s just not as significant as people believe.”
Indeed, China only accounted for 3% of the company’s total revenue in the latest quarter. And Caterpillar said it still expects the country’s economy to grow a healthy 8.5% this year. The company is also taking steps to reduce its higher inventory levels in China by redirecting equipment to countries where it’s in higher demand.
Some analysts took the view that the shift to North America from emerging markets is actually a positive for Caterpillar. Morningstar analyst Adam Fleck, for example, told Reuters that Chinese buyers tend to purchase smaller, less expensive machinery, while clients in more developed countries often make bigger purchases.
So could another big acquisition be in the cards for Caterpillar? Most analysts think not, as the company still has its hands full integrating Bucyrus and its other recent purchases. But that said, Caterpillar has never been slow to buy up companies that add to its product lineup—and it usually makes them much more profitable when it does.
Article originally posted here.