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Caterpillar Preview: China, Margins Dominate Caterpillar Concerns

Investors will pay particular attention to what Caterpillar has to say about China and its profit margins when the bellwether reports before the bell Thursday.
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NEW YORK (TheStreet) -- Caterpillar (CAT) - Get Caterpillar Inc. Report will report third-quarter results Thursday morning, and investors will be interested in two things when new CEO Douglas Oberhelman gets on the horn for his conference call at 10 a.m. EDT: profit margins and China.

First, let's get the basic numbers out of the way. Analysts as polled by the sell-side surveys are, on average, projecting Caterpillar's profit at $1.09 a share for the third period, on revenue of $10.48 billion.

That would mean year-over-year growth of 70% on the bottom line and 44% on the top. The company earned 64 cents on volume of $7.3 billion in the third quarter of 2008, when business was as wretched for CAT as it had been in recent memory.

Shares of the industrial bellwether from Peoria had marched higher since late August, setting a series of 52-week highs in September. The stock punched above $80 for the first time since June 2008, at the cusp of the financial crisis. In recent sessions, though, CAT shares have cooled off some, perhaps as valuations have grown dear. The stock's trailing price-to-earnings ratio reached 32.5, compared with the S&P 500 average of 18.2.

Tuesday's surprise

rate hike by China's central bank

didn't help the outlook for CAT stock. Though the company still does less than 10% of its business in the People's Republic, Caterpillar has banked a large portion of its growth targets on the booming region. And, amid the recession, Chinese demand for yellow bulldozers and backhoes and mining trucks has kept Caterpillar from falling off a cliff.

What Caterpillar has to say about China, especially given its recent moves to cool down its economy and stave off inflation, will be high on many investors' minds Thursday. "Any feedback on China tomorrow is important," says Jeff Windau, an analyst Edward Jones in St. Louis. Caterpillar typically offers a fairly detailed macro-outlook of global economic trends in its quarterly reports.

Investors will also study Caterpillar's profit margins, Windau said. Other big industrial-equipment concerns, most notably

Parker-Hannifin

(PH) - Get Parker-Hannifin Corporation Report

this week, have registered record margins early in this third-quarter reporting season. (The diversified machine manufacturer said its profit tripled.)

Similarly, CAT-watchers want to make sure that the company's managers out in Peoria are maintaining their cost discipline as demand for Caterpilllar gear rises from the total bottom reached in 2009 -- highly tentative though the recovery might be.

Caterpillar's so-called incremental margins have caused a bit of concern, disappointing some analysts

in the second quarter

. (Incremental margins refer to the profit a company takes from each additional dollar of revenue it turns. The figure is a measure of how well a company is executing as it increases manufacturing capacity to meet rising demand.)

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In the second quarter, Caterpillar's incremental margins were 26%. Because the company posted revenue growth in the period of about 30%, some observers felt incremental margins should have surmounted 30% as well.

Aside from the emerging markets (including Brazil as well as China), Caterpillar has benefited of late from swift business for its mining equipment. Strength in that segment has largely propelled the recent gains Caterpillar has reported in its monthly retail sales updates.

But it's something of a double-edged sword for Caterpillar. Sales of mining machinery increase during moments of expanding demand -- and prices -- for minerals and metals. But increasing metals prices means higher raw materials costs for manufacturers such as Caterpillar. Analysts want to see how well (or how poorly) Caterpillar is dealing with this tricky balance.

One lever it can pull, of course, is to hike prices for its equipment. Indeed,

Caterpillar said recently

that it will do just that at the start of next year. But with demand for construction equipment still in the tank in North America and Europe, some skeptics wonder at the company's ability to do that to prospective customers smarting from the recession.

One bullish signal for the construction industry emerged on Wednesday, however, when the American Institute of Architects released its monthly billings index. The measure jumped to 50.4, showing the first positive reading since January 2008. (Like many such metrics, anything above 50 indicates growth.)

Because it takes nine to 12 months on average for construction to begin after an architect is hired (the average includes both residential and commercial projects), the AIA index provides at least one narrow glance through the keyhole at how the construction business will look a year from now.

-- Written by Scott Eden in New York

RELATED STORIES:

>>Caterpillar Announces Price Hikes

>>Caterpillar Retail Sales Jump in August

>>Caterpillar Recovery Draws Worrywarts

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