The issue of profit margins will also be a sticking point, once again. That's because Caterpillar, during the last upcycle, fumbled the ball in the opinion of some observers. Critics say that fractured supply-chain processes didn't allow Caterpillar to take full advantage of rapidly increasing demand. In other words, it was slow to ramp up manufacturing speed as demand spiked. Thus, the company left profits on the table. The commodities boom is a bit of a double-edged sword for Caterpillar. Sales of mining machinery will rise during moments of expanding demand for metals and minerals, of course. But rising commodities prices also result in 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. Caterpillar has spent the last two years attempting to revamp its manufacturing processes to correct the problems. And now that the next upcycle is upon us, analysts and investors are paying special attention to the company's "incremental margins." The metric refers to the profit a company is able to squeeze from each additional dollar of revenue it turns. In essence, the figure is a measure of how well a company is executing as it increases manufacturing capacity to meet rising demand. Caterpillar has told analysts that it wants its incremental margins to come in at about 25%. Anything much lower than that -- 15% or 20%, say -- will cause much handwringing. Caterpillar doesn't break that number out. You have to calculate it yourself. Here's how: Take the year-over-year change in operating income and divide it by the year-over-year change in revenue. Voila. However, be sure the income and revenue numbers are from the company's two manufacturing segments only -- engines and machines. Obviously, the company's finance unit, for example, should be excluded. Caterpillar had a busy fourth quarter. It bought the mining-equipment specialist Bucyrus for $8.6 billion including debt, the most expensive acquisition ever attempted by the industrial icon. (Though, in truth, we haven't gone back and looked at other deals and adjusted for inflation. There was, for example, the 1925 merger between the Holt Manufacturing Co., of Stockton, Calif., and East Peoria, Ill., and the C.L. Best Tractor Co., of San Leandro, Calif. -- the origin-deal that formed the concern that we have come to know as Caterpillar.) Caterpillar's Bucyrus acquisition -- though it raised eyebrows at the time for the seemingly steep price paid by CAT -- further underscored the reasons behind the company's recovery from one of its worst years ever, in 2009. Mining equipment and emerging economies have saved Caterpillar's business at a time when one of its core markets -- construction in North America -- has remained in the tank.
Some industry experts say construction equipment sold in the United States is no longer Caterpilliar's core business. The company itself has made no bones about the reasons behind its recovery. It's been the investment story of the last year and a half: "Developing economies are leading our growth in 2010," CAT said in its third-quarter release. According to Robert McCarthy, an analyst covering Caterpillar at R.W. Baird, North America as a whole (which includes both the booming mining equipment segment and the still-ugly construction equipment segment) accounted for only one-third of CAT's sales in 2010. "Clearly the piece that's related to construction in North America is not what drives the company's numbers," McCarthy said. Still, several recent indicators have pointed to a potential rebound in sales of construction gear in the U.S. On the residential side, the latest data point came Wednesday, with new home sales in December rising 17%. "I think there's broad evidence that the U.S. construction market is trying to find a bottom," McCarthy said. "That's a better place to be than six months or a year ago." -- Written by Scott Eden in New York >To contact the writer of this article, click here: Scott Eden. >To follow the writer on Twitter, go to http://twitter.com/ScottEden. >To submit a news tip, send an email to: email@example.com.