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Caterpillar Inc. (CAT - Analyst Report) posted record EPS of $2.54 in the third quarter of 2012, a 49% increase from $1.71 in the prior-year quarter, way ahead of the Zacks Consensus Estimate of $2.21. EPS in the quarter included a pre-tax gain of $273 million from the sale of a majority interest in Caterpillar’s third party logistics business.
 
Revenues increased 5% to $16.4 billion in the quarter, but fell short of the Zacks Consensus Estimate of $16.7 billion. Improvement in sales volume, favorable price realization and positive net impact of acquisitions and divestitures were partially offset by foreign currency translation. Sales of new equipment increased while sales of aftermarket parts were almost flat. Sales in North America increased 9%, and in Asia/Pacific were up 8% while sales in EAME and Latin America were about flat.  
 
Cost of sales increased 2% to $11.6 billion in the quarter. Manufacturing costs upped $259 million as a result of higher period costs related to production volume and capacity expansion programs.
 
Selling, general and administrative (SG&A) expenses increased 8% to $1.47 billion and research and development (R&D) expenses jumped 9% to $634 million attributable to growth-related initiatives, increased costs to support product programs. 
 
Higher sales volume, impact of acquisitions and divestitures and improved price realization helped offset the rise in manufacturing costs, SG&A and R&D expenses and were responsible for a 48% surge in operating profit to $2.6 billion. Operating margin improved 460 basis points to 15.8% in the quarter.
 
Segment Results
 
Machinery and Power System (M&PS) revenues increased 5% to $15.7 billion. Construction Industries sales were flat as higher sales in North America and EAME were offset by declines in Asia/Pacific and Latin America. Sales increased in Resource Industries mainly on the back of higher volume and improved price realization. Power Systems sales increased as a result of improved sales volume and price realization, partially offset by the impact of currency. Machinery and Power System’s operating profit jumped 48% to $2.48 billion from $1.68 billion in the prior-year quarter.
 
Financial Products’ revenues increased 3% to $776 million as the positive impact of higher average earning assets were offset by an unfavorable impact of lower average financing rates on new and existing finance receivables and operating leases. Financial Products’ profit increased to $190 million from $145 million in the third quarter of 2011. The increase was attributed to an $18 million impact from lower claims experience at Cat Insurance and a $26 million favorable impact of higher average earning assets.
 
Financial Position
 
Caterpillar had cash and short-term investments of $5.7 billion as of September 30, 2012, up from $5.1 billion as of June 30, 2012. Total debt-to-capital ratio improved to 64% as of September 30, 2012 from 67% as of June 30, 2012. The debt-to-capital ratio at M&PS decreased to 38% at the end of the reported quarter from 40.9% as of the second quarter end.
 
Total cash flow from operating activities in the first nine months of fiscal 2012 was $3.3 billion compared with $5.5 billion in the prior-year comparable period. Operating cash flow at M&PS declined to $994 million in the third quarter of 2012 from $2.04 billion in the prior-year quarter, due to unfavorable changes in working capital.
 
Outlook
 
Caterpillar has lowered its sales guidance to $66 billion from the prior guidance of $68 billion to $70 billion due to weaker economic conditions across most of the globe. The company has also trimmed its EPS expectation to a range of $9.00 to $9.25 from the previous $9.60. For fiscal 2013, sales are expected to be positive 5% to negative 5% from 2012 levels.
 
Caterpillar estimates that the world economy would grow about 2.5% in 2012, the weakest annual growth since 2009. However, for 2013, the company is expecting slightly improved economic growth of about 2.7%. Though modest improvement is expected in the U.S., China and the developing world, Europe is expected to remain weak.
 
Our Take
 
Even though the company lowered its guidance for 2012, if realized, would mark the highest revenues and profit in Caterpillar’s history, even ahead of last year’s ground-breaking results. Furthermore, the Bucyrus acquisition has positioned Caterpillar as the leading global mining original equipment manufacturer. 
 
Caterpillar recently trimmed its 2015 guidance in the wake of weaker-than-expected growth in the global economy. Factoring in tepid economic growth through 2015 and a less likely scenario of a worldwide recession, Caterpillar expects to generate revenues in the range of $80 billion to $100 billion in 2015 and earnings per share in the range of $12 to $18 per share. Caterpillar had earlier estimated earnings between $15 and $20 per share. 
 
Caterpillar had been persistently adding production capacity for many of its products. However, with the growing concerns and uncertainty about the pace of world economic growth, short-term economic risks in the U.S, the Euro zone debt crisis and the slowdown in China's growth,
 
Caterpillar has now opted to be cautious regarding acquisitions and investments in expansion. Production across much of the company has been lowered, leading to temporary shutdowns and layoffs. The company remains hopeful that construction activity in the emerging markets will witness modest improvement. The company plans to remain focused on its cost control measures and continue to invest in research and development. 
 
Caterpillar’s plans to expand in the mining and China is currently under pressure as mining companies are revisiting and trimming their capital expenditures plans following the slowdown in economic expansion in China, the world’s largest user of coal and metals. The recent loss of sales momentum, margin headwinds, negative impact of the European debt crisis and a slowing Chinese economy remain concerns. The shares of Caterpillar are currently maintaining a Zacks #5 Rank (Strong Sell) over the short term.
 
Peoria, Illinois-based Caterpillar Inc. is the manufacturer of construction and mining equipment, diesel and natural gas engines, and industrial gas turbines. The company is one of the few leading U.S. companies in an industry that competes globally from a principally domestic manufacturing base.
 
Caterpillar operates two divisions – M&PS and Financial Products. It competes with the likes of CNH Global NV , Komatsu Ltd. (KMTUY), Joy Global Inc (JOY - Analyst Report) and Deere & Company (DE - Analyst Report). 

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