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On Feb 22, we downgraded our recommendation from Neutral to Underperform on Caterpillar Inc. (CAT), leading manufacturer of construction and mining equipment, given the impact on its margin due to the ongoing inventory correction, recent loss of sales momentum, declining backlog, negative impact of the European debt crisis and a slowing Chinese economy. Caterpillar retains a short-term Zacks Rank #3 (Hold).

Why the Downgrade?
 
Reduced sales, lower production and a decline in inventory primarily resulted in lower fourth quarter 2012 earnings for Caterpillar. However, the company reported record fiscal 2012 with respect to both earnings and revenues. In the fourth quarter, adjusted EPS was $1.91, down 18% from $2.32 in the prior-year quarter. Revenues declined 7% to $16.1 billion in the quarter due to the impact of changes in dealer new machine inventories. 
 
Caterpillar remains challenged by slowing demand and inventory correction as a result of higher production than demand. The company expects sales in the first quarter of fiscal 2013 to decline more than $2 billion annually as dealers are expected to continue to resize inventory levels to match demand. Earnings will be affected by lower-than-expected sales and the negative cost impact of continuing low production levels and declining inventory. For fiscal 2013, sales are expected to be in the range of $60 to $68 billion, down 9% to up 3% from 2012 revenue. Caterpillar had previously stated that revenue would be down 5% to up 5% from 2012 actual sales. Earnings are expected to be between $7.00 and $9.00.
 
Caterpillar’s ended the year with a backlog of $19.6 billion, a 15% sequential and a 34% annual decline. Caterpillar will need additional orders during the year to meets its guidance. Furthermore, Caterpillar’s sales declined 4% worldwide in the trailing three-months ending January as sales in North America and Asia remained. This has worsened from the sales decline of 1% worldwide in Dec 2012. Caterpillar’s sales growth turned negative in December for the first time in 30 months, hurt by tougher year-earlier comparisons and rising inventories of unsold equipment.
 
The European debt crisis has 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,
China’s economic growth has cooled down from robust levels witnessed over the last decade. The economic slowdown in 2012 unfavorably impacted infrastructure and construction spending with an impact on Caterpillar’s sales.
 
Other stocks to consider
 
Other construction machinery makers with a favorable Zacks rank are Astec Industries, Inc. (ASTE - Analyst Report), H&E Equipment Services Inc. (HEES - Snapshot Report), Deere & Company (DE - Analyst Report), all carrying Zacks Rank #2 (Buy).

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