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What Is Caterpillar Not Telling Investors?

Caterpillar goes conservative with its 2010 earnings forecast -- but is the manufacturing bellwether putting all its cards on the table?
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(Caterpillar earnings analysis updated for further commentary and for closing stock prices.)



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stepped forward Wednesday with earnings guidance for 2010 that came in below Wall Street expectations, a forecast that weighed heavily on the company's shares.

But at other points in its earnings report, the Peoria, Ill., bellwether seemed more optimistic than those numbers might imply. Readers of the report had to wonder if Caterpillar's top-siders, burned by overly bullish calls in the past, were putting all their cards on the table.

Before the bell Wednesday, the world's largest maker of construction equipment

easily surpassed analysts' estimates for its fourth-quarter profit


All eyes, however, were locked onto the outlook: Caterpillar appeared to dampen expectations substantially when it predicted a 2010 profit of $2.50 per share. According to a Thomson Reuters survey, analysts were targeting $2.71 a share.

Investors reacted forcefully and predictably to the EPS forecast. Wednesday morning, Caterpillar shares fell by as much as 7% on manic volume.

There's also the matter of Caterpillar's previously issued revenue guidance for this year -- it expects top-line growth in the range of 10% to 25% from 2009's $32.4 billion. Some observers have called that target range

unrealistically bullish, which the company indeed has a history of being.

But a closer look at Caterpillar's report reveals that its executives are almost certainly managing expectations with a prediction toward the low end of what it believes it can achieve this year.

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"Most likely, it will end up proving conservative," Larry DeMaria, an analyst at Sterne Agee in New York, said of Caterpillar's guidance. He, for one, is forecasting a profit of $3 a share in 2010.

If the prepared statement of company boss Jim Owens is to be believed, Caterpillar has seen demand begin to rebound. "Dealer sales to end users are up, order rates are up, dealer inventories came down in 2009, and we're seeing stronger service parts sales," Owens said in the press release. (The company and its reeling dealerships have spent the better part of last year attempting to rid themselves of bloated inventories. As expected, Caterpillar dealers have de-stocked more than $3.3 billion worth of inventory in 2009.)

To provide for the world's increasing hunger for yellow-painted heavy equipment, Owens went on, Caterpillar plans to begin increasing production and ordering more parts from suppliers as it ramps up its plants (many were idled and more than 19,000 workers were laid off in 2009) in preparation for what it believes is a coming recovery.

During a conference call with analysts later Wednesday, Owens reiterated the importance of being prepared to ramp up production almost at a moment's notice. He said that the company will have the ability in 2010 to flip the switch on manufacturing capacity that could handle annual sales of $50 billlion -- about the same revenue figure it achieved in 2008, before the full impact of the recession had set in.

But perhaps the most telling piece of evidence signaling the depth of Caterpillar's optimism lies in the company's quarterly macroeconomic outlook.

The company isn't called a bellwether for nothing. Because it sells its equipment into a variety of fundamental industries across the planet -- none more indicative of economic health than mining and construction -- the company has an uncommonly bird's eye view of global trade.

So when it makes its macro predictions, people generally take notice, and in this respect, it looks as though Caterpillar has gone aggressive, forecasting U.S. GDP growth in 2010 of 3.5%. That's well above the most-recent IMF prediction, for instance, which is calling for expansion of 2.7%.

Still, causes for concern remain, and the company's glasses weren't completely shrouded in the color rose.

No matter how much its executives like to talk about emerging markets (especially China) and the huge growth opportunities there, Caterpillar's fiscal fitness depends on North America -- and specifically on the construction industry in North America. Until that sector rises from the dead, then, Caterpillar won't really be at full health.

Thus, for the Caterpillar investor, the following line from the company on the 2010 construction business might cause some worry: "We expect continued decline in nonresidential building construction."



market data released on Wednesday also had worrisome undertones for Caterpillar. According to the U.S. Census Bureau, new home sales in December fell to a nine-month low, while mortgage applications tumbled 11% last week. Both indicators do not bode well for sales of the equipment that moves the dirt upon which new houses are built.

Also, don't expect any relief from the long-promised stimulus spending that would go toward infrastructure improvements and expansion. As Caterpillar put it, rather diplomatically, "Delays in passing a highway bill likely will cause highway contractors to remain cautious about purchasing equipment." As one Caterpillar analyst put, rather less diplomatically, "Infrastructure spending? It's basically a joke. It's just a bunch of bloviating from Washington."

The steep selloff in Caterpillar shares moderated toward the end of Wednesday's session. The stock closed the day at $53.44, down $2.4, or 4.3%. Volume reached nearly 34 million shares, swamping the average daily turnover in the name of 7.9 million.

-- Written by Scott Eden in New York


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