Caterpillar Outlook: Mine, Baby, Mine!

Recent sales data from Caterpillar suggests that the long slide in demand for its construction gear has finally come to an end -- but a closer look reveals the risks the company faces as it strives to meet its growth targets.
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(Updated to correct a misreported description of Caterpillar's three-month dealer sales report. The figures in that report reflect sales by Caterpillar's dealers to end users, and not simply sales of the company's equipment to its dealers, as this story originally stated.)

PEORIA, Ill. (


) -- When


(CAT) - Get Report

released several bits of sales data this past Friday, the numbers appeared to suggest that the long slide in demand for its construction gear, from bulldozers to backhoes, had finally come to an end.

As is its wont, Caterpillar offered the figures without comment. The headline number appeared to be a bullish one: Worldwide machine sales rose 11% in May from a year ago. The public-relations people out in Peoria were doubtless pleased that the report was almost uniformly applauded as the first year-over-year gains Caterpillar has registered in that category since September 2008, at the scariest moment of the financial crisis.

Even more, plenty of optimists out there will want to interpret these bits of information to mean that -- lo and behold -- the moribund U.S. construction industry has risen from the dead. The sector has been so beleaguered that it led the broader economy into recession in late 2007 even as it's now dragging on what appears to be a recovery, like a parachute behind an airplane.

But it's worth understanding what these Caterpillar data actually are -- and what they decidedly are not. For one thing, the figures reflect retail sales of the company's engines and rolling machines to end users. For another , the company only reported the percentage year-over-year change for each of those three months, not dollar figures. And, lastly, all of it is unaudited.

The fact remains that the growth enjoyed by Caterpillar in May has come off an extremely low base. So low, in fact, that had the company


reported what it reported, the market would have been shocked. Said Alexander Blanton, the heavy equipment analyst at Ingalls & Snyder, "If

the May growth hadn't happened, it would've been quite negative."

Caterpillar's U.S. sales in May, which rose 15% compared with the same month of 2009, generated particular interest among some investors. That's because May represents the first time in four years that Caterpillar's monthly machine sales in the U.S. have grown year-over-year -- not since the peak of the construction boom way back in 2006. But, once again, the comparisons are extremely easy, disguising at least for a moment just how bad things have been for Caterpillar's construction business, and likely will remain for some time. Even including the reported May uptick, domestic sales of Caterpillar machinery are still down 64% from that 2006 peak -- far worse than the retraction in the U.S. construction industry at large, which has shrunk by about 20%.

The reason for that discrepancy? Contractors, reacting to the vicious recession in their industry, scaled back on their equipment purchases even more drastically than developers scaled back on construction projects. Four years later, with older equipment gathering rust and breaking down, it's only natural that contractors -- and Caterpillar dealers -- would need to refresh their fleets with at least a few pieces of new equipment.

That's one theory, at least.

To other Caterpillar watchers, the company's sales jump in May likely came from a different slice of its business: mining equipment. A surge in metals values through 2009 and into the beginning of this year sparked a resurgence in capital expenditures by big mining companies.

Freeport McMoRan

(FCX) - Get Report

, for example, has been working to bring into service a series of

mining projects in North America

, moth-balled because of the recession.

Activity such as Freeport's has likely translated into a lot of 150-ton trucks rolling off Caterpillar factory floors. "My feeling is that mining equipment has helped fuel and save this company," said Charles Yengst, a heavy-equipment forecasting consultant. "Overall, it would be in terribly bad shape if they didn't have these big mining trucks."

Caterpillar provided some of its own validation of this thesis when, last week, it announced that it was getting back into the

mining-shovel business

, a segment it had exited, after some disappointing experiences, in 2003. Now, apparently, the company sees enough strength in the mining industry that it believes a return to this competitive slice of the trade will be lucrative. (



, for one, has a robust shovel business, as do international heavyweights such as

Hitachi Construction Machinery




Because practically no one expects the U.S. construction industry to emerge from its funk until 2011 at the earliest, Caterpillar needs the mining business to stay robust in order to meet its growth targets for the year. Back in April, the bellwether said it

wants to achieve top-line growth

in 2010 of 17% to 30%.

Still, the company has predicted that dealer inventories will remain flat in 2010 with the levels reached at year-end 2009, suggesting that Caterpillar understands that the construction-equipment business will continue to be as sluggish as the pace of construction at One World Trade Center.

The risk now for Caterpillar lies in the price of industrial metals, from copper to zinc. If prices rise or stay at present levels, the company's mining gear will sell. If, however, prices continue to slip, Caterpillar may have a hard time meeting expectations.

The price of industrial metals, in turn, hinges on China. Indeed, metals prices have weakened since April on fears that China's moves to end rampant speculation in its real estate markets and stave off the creation of a dangerous asset bubble will lead to a slower-growing economy in the People's Republic. Because Chinese industry has come to dominate global trade in raw materials, any softening there will without question hurt metals prices.

Caterpillar is, in a sense, doubly on the hook to China. Along with mining equipment globally, the company has relied on relatively decent sales in Asia to offset the weakness in Europe and the U.S. In May, for instance, Peoria said sales in Asia surged 38% year-over-year.

It's probably no surprise to anyone that Caterpillar's growth outlook rests on China and, to a narrower degree, on the nation's construction business. The news over the weekend that officials in China planned to

release the yuan

, like a falconer liberating his bird, may have improved Caterpillar's outlook, but for reasons more having to do with psychology than any concrete impact on sales of earthmovers.

That's because Beijing, in making public waves with its currency plan, also signaled optimism to the market. The nation's ministers must have confidence that no "hard landing" awaits China's economy. Otherwise, they wouldn't have made the announcement, or so the logic goes.

-- Written by Scott Eden in New York


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Scott Eden has covered business -- both large and small -- for more than a decade. Prior to joining, he worked as a features reporter for Dealmaker and Trader Monthly magazines. Before that, he wrote for the Chicago Reader, that city's weekly paper. Early in his career, he was a staff reporter at the Dow Jones News Service. His reporting has appeared in The Wall Street Journal, Men's Journal, the St. Petersburg (Fla.) Times, and the Believer magazine, among other publications. He's also the author of Touchdown Jesus (Simon & Schuster, 2005), a nonfiction book about Notre Dame football fans and the business and politics of big-time college sports. He has degrees from Notre Dame and Washington University in St. Louis.