Caterpillar Loses Legs

The tractor-maker gets crushed after guidance cut.
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Updated from 11:23 a.m. EDT

After a big run,

Caterpillar

(CAT) - Get Report

signaled Friday that it may be slowing to a crawl.

The construction-equipment giant posted third-quarter earnings that missed and cut its outlook for the year, citing higher costs and a weakening housing market. The company also issued a weak 2007 guidance, saying it expects a "pause" in U.S. economic expansion.

The news sent shares of the

Dow

component tumbling 13% and weighed on other stocks in the heavy-equipment sector.

Caterpillar earned $769 million, or $1.14 a share, for the quarter ended last month, up from the year-ago $667 million, or 94 cents a share. Revenue rose 17% from a year ago to $10.52 billion.

Analysts surveyed by Thomson Financial were looking for a $1.35-a-share profit on sales of $9.87 billion.

In Caterpillar's machinery division -- which represents about two-thirds of profits -- sales increased 15% in the third quarter, but margins fell due to higher manufacturing and sales costs. This resulted in just 2% operating growth in the division.

But it was Caterpillar's outlook that rally tore at the stock. The company's trimmed its 2006 profit forecast to $5.05 to $5.30 a share from the previous projection of $5.25 to $5.50. The company expects sales to rise 13% from a year ago to $41 billion. Analysts were looking for earnings of $5.52 a share and a top line $40 billion.

For 2007, Caterpillar expects its profit to rise as much as 10% on sales growth of up to 5%.

"We're expecting slightly higher sales and revenues in 2007 despite the prospects of a slowing U.S. economy, a sharp drop in sales of on-highway truck engines and weaker housing construction," CEO Jim Owens said in the company's earnings press release.

This limited sales growth next year reflects "increasing risks that have developed in the U.S. and an expectation that our dealers will reduce inventories significantly," the company said.

Caterpillar has been a consistent earnings outperformer over the past year as it benefited not only from increased housing construction but booming markets for mining- and energy-related equipment, as well as higher pricing. But the company's warnings Friday indicated that it may be facing broader economic headwinds next year.

"We believe 2007 will be a slowdown in the current cycle, not the start of an extended downturn," the company said. Caterpillar also said it expects the slowing economy will lead the

Federal Reserve

to cut interest rates in the first half of 2007, probably by 50 to 100 basis points.

On its conference call, Caterpillar admitted that if the Fed cuts rates earlier enough next year, then the company could beat its current profit forecast for 2007. However, management denied that it was being deliberately negative about the economy next year.

"I think we're being very prudent with our forecast. We are in for a pause here," Owens said on the call. "We're not trying to be deliberately conservative...I think we're just being realistic after what has been a phenomenal run the past five years."

The U.S. economy slowed to a 2.6% rate of growth in the second quarter of 2006, and the company projects third-quarter growth to be even slower, possibly below 2%. The slowdown has been concentrated in consumer spending and housing, the company said.

Caterpillar said its dealers, which operate independently of the company, continue to cut back on inventories amid declining sales of small machines used residential construction. As well, dealers believe they can get products from the company more easily now, so they don't have to stock up on inventory, Caterpillar's management said on the call.

Aside from the projection for weakness in housing construction and on-highway truck engines for next year, Caterpillar said most other markets shouldn't see a downturn.

"Overall we do no see 2006 or 2007 as the peak in this growth cycle for most of the industries we serve," Owens said, pointing to the mining sector as an example of an area of strength.

Shares of Caterpillar recently were down $9.22 to $59.80.

Moreover, the weak outlook from the industrial bellwether sent shares of other heavy-equipment and construction companies sliding.

Terex

(TEX) - Get Report

was down $4.61, or 8.3%, to $50.69;

Deere

(DE) - Get Report

fell $3.28, or 3.8% to $83.54; and

Manitowoc

(MTW) - Get Report

declined $2.89, or 5.7%, to $47.81.