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On Nov 12, we downgraded Caterpillar Inc. (CAT - Analyst Report), a leading manufacturer of construction and mining equipment, from Neutral to Underperform given its lackluster third quarter results, trimmed outlook for 2013, declining backlog and negative impact of the European debt crisis. Caterpillar retains a Zacks Rank #5 (Strong Sell).

Why Downgraded?

Reduced mining demand led to a 43% slump in third quarter 2013 earnings of Caterpillar to $1.45 per share and an 18% decline in revenues to $13.4 billion in the quarter. Sales volume decreased $2.7 billion, with changes in dealer inventories accounting for over 50% of the decline.

Caterpillar’s worldwide sales declined 9% for the three months ending Sep 2013, the tenth consecutive month of sales decline. Latin America, which has otherwise outperformed other regions in 2013 with positive growth in contrast to decline across the board, disappointed again with a 10% dip in September, worsening from the 3% sales dip in August. Asia dragged down overall results with a 24% decline and EAME was down 11%.

Caterpillar forecasts sales in the fourth quarter to be slightly higher than in the third quarter, but it cautioned that earnings per share will be lower due to higher costs resulting from seasonal spending patterns. The company also expects another substantial decline in dealer inventories in the fourth quarter.

For fiscal 2013, Caterpillar now projects sales of $55 billion, down from the previous range of $56 billion to $58 billion. Caterpillar now expects to earn $5.50 per share in 2013, down from the earlier projection of earnings of $6.50 per share due to lower sales volume including an unfavorable mix of products and lower price realization. This is the third quarter in a row in which Caterpillar has trimmed its fiscal 2013 guidance.

Caterpillar ended the quarter with a backlog of $19.1 billion compared with $23.1 billion at the end of the third quarter of 2012. The decline was due to a substantial reduction in mining-related products within Resource Industries, which was partially offset by an increase in Construction Industries. Caterpillar will need additional orders during the year to meet its guidance.

The European debt crisis had a negative impact on Caterpillar’s results. The continuation of economic uncertainty in the region will continue to be a headwind moving forward. Furthermore, emerging markets, like China, are now showing a contraction from robust levels witnessed over the last decade. Major mining companies are cutting their spending budgets to prioritize improved production at existing projects rather than resorting to new project expansion. These headwinds could weigh on Caterpillar’s growth and operating performance over the next several quarters.

Other Stocks to Consider

Stocks in the industrial products sector with a favorable Zacks Rank are Xylem Inc. (XYL - Analyst Report) with a Zacks Rank  #1, and Alamo Group, Inc. (ALG - Snapshot Report) and H&E Equipment Services Inc. (HEES - Snapshot Report) with a Zacks Rank #2 (Buy).

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