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Caterpillar (CAT) Bets on Strong Demand Amid High Costs

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Caterpillar Inc. (CAT - Free Report) is well-poised for delivering improved results this year, backed by strong backlog levels, solid demand for construction and mining equipment, and its ongoing cost control efforts. A robust liquidity position, investments focused on expanding offerings and services, and digital initiatives like e-commerce are likely to drive growth for the company in the long haul.

High Demand to Offset Costs in 2021

Caterpillar’s backlog at the end of the second quarter of 2021 was $18.4 billion, which was up $1.5 billion on a sequential basis. This is likely to get reflected in the third-quarter performance. The company along with other players in the same industry such as Terex Corporation (TEX - Free Report) , The Manitowoc Company, Inc. (MTW - Free Report) and Astec Industries, Inc. (ASTE - Free Report) have been witnessing higher material costs lately, particularly of steel and other commodities. These companies are also grappling with higher freight costs, labor constraints and supply chain headwinds, which are expected to hinder their margins this year.

On top of this, Caterpillar anticipates incentive compensation of about $1.5 billion for the year, which remains a headwind. This will lead to higher SG&A expenses through the year. The company is ramping up R&D project spending to support services growth strategy and new product development. Despite these factors weighing on margins, Caterpillar’s ongoing restructuring efforts and higher demand witnessed in its markets will drive growth.

Segments Show Promise

In North America, demand from both residential and non-residential construction will boost sales for Caterpillar’s construction equipment. With the U.S Senate passing the $1-trillion infrastructure bill, the perked-up investment in roads, bridges, airports and waterways represents a huge opportunity for Caterpillar. The outlook for the construction sector holds promise in the rest of the world as well.

In Resource Industries, mining orders have been witnessing an uptrend, courtesy of improving metal prices. There has been an improvement in heavy construction and quarry and aggregates, particularly in North America and the EAME. This is anticipated to continue through the year. Miners are increasingly opting for autonomous systems to increase productivity and reduce costs. To capitalize on this trend, Caterpillar is enhancing its autonomous capabilities and bringing innovative products to markets.

In the Energy & Transportation segment, the Oil & Gas sector is anticipated to regain strength gradually. The company expects improvement in power generation, supported by data center activity. It envisions sales to improve in transportation, courtesy of an increase in rail services and international businesses. It anticipates modest growth in the marine business as well. Industrial expects to witness growth, with activity strengthening across most applications.

Solid Balance Sheet to Aid Growth

Caterpillar’s cash and liquidity position remains strong with the company ending second-quarter 2021 with cash and short-term investments of $10.8 billion. ME&T debt at the end of second-quarter 2021 stood at $9.7 billion. It is on track to deliver its ME&T free cash flow target of $4-$8 billion for 2021.

The company continues to focus on customers and the future by continuing to invest in digital capabilities, connecting assets and job sites, and developing the next-generation productive and efficient products. It plans to fund initiatives that drive long-term growth focused on areas of expanded offerings and services, and digital initiatives like e-commerce.