Caterpillar CEO inherits target 32% above estimates

Caterpillar Inc.'s new Chief Executive Officer Doug Oberhelman inherited an earnings target that analysts project he won't meet.

Oberhelman, 57, took over as CEO from Jim Owens on July 1, a job that came with a 2012 target for earnings of $8 to $10 a share. That's at least 32 percent more than the $6.08 average estimate of analysts tracking the Peoria-based company, according to data compiled by Bloomberg.

Investors are looking for the world's largest maker of construction equipment to avoid a repeat of the last time there was sustained sales growth, when Caterpillar failed to raise profit. The company is boosting output to meet increased orders. It announced in the past seven weeks at least $1.52 billion of investment to raise truck and engine output and make shovels.

"Show me that you can improve your inventory management, manage your raw-material inflation and show me you can expand operating margins," said Joel Levington, a managing director of corporate credit at Brookfield Investment Management Inc. in New York, who tracks Caterpillar because it's the largest debtor among U.S. industrial companies after General Electric Co. He declined to comment on the firm's holdings.

"You need more than just revenue growth," he said.

Caterpillar rose 48 cents, or 0.7 percent, to $66.91 as of 8:35 a.m. in premarket trading on the New York Stock Exchange.

Caterpillar is due to report second-quarter results tomorrow. Adjusted earnings will be 84 cents a share, according to the average of 20 analyst estimates compiled by Bloomberg. Caterpillar, which is forecasting full-year earnings of $2.50 to $3.25, declined to comment.

'Too Little Time'

"If the company produces higher-than-anticipated earnings in the short term as we expect, investors may begin to place a higher probability on Caterpillar's ability to achieve its longer-term revenue and earnings targets," Andrew Casey, an analyst for Wells Fargo in Boston who rates the shares "outperform," wrote in a June 28 report.

Caterpillar's so-called incremental operating margin, or the profit on each additional dollar of revenue, shrank in 2007 and 2008, according to data compiled by Jefferies & Co. Sales rose 24 percent from 2006 to 2008 while profit was flat as the company paid more for raw materials and to get parts faster from suppliers.

Caterpillar's costs in 2007 and 2008 rose as the company stepped up production to meet surging demand, said Mark Demos, a portfolio manager in Minneapolis for Fifth Third Asset Management Inc., which holds 125,379 Caterpillar shares as part of $17.8 billion under management.

Komatsu, Deere

"They tried to produce too much in too little time," Demos said.

Japan's Komatsu Ltd., Caterpillar's largest competitor, increased earnings by 83 percent and revenue by 39 percent in the two years through March 2008. Deere & Co., a Moline, Illinois-based manufacturer of farm and construction equipment, boosted profit by 21 percent and sales by 30 percent in the two years through October 2008.

Caterpillar has gained 17 percent this year in New York, making it the second-biggest climber on the Dow Jones Industrial Average. Deere rose 12 percent while Komatsu dropped 11 percent.

In the past two years, Caterpillar raised capacity, shrunk its supplier base and improved the way it buys materials, said Robert Wertheimer, an analyst at Morgan Stanley in New York.

"A lot of ground work has been laid," he said. "What the company needs to do is execute."

Factory Efficiency

Caterpillar reported improved factory efficiency and margins in January through March. Stronger growth in construction may also make Caterpillar's goal achievable. Reporting first-quarter results in April, the company forecast improving economic growth would fuel sales and earnings, especially in emerging markets.

Caterpillar got 63 percent of its revenue from outside North America in the first quarter.

The International Monetary Fund said July 8 that global growth this year will be stronger than previously forecast while warning that turmoil stemming from Europe's fiscal problems has heightened the risks to the recovery. Problems in advanced economies may curb capital flowing into emerging markets, said Olivier Blanchard, the IMF's chief economist.

"We need to a have a really strong economic recovery" for Caterpillar to hit its 2012 earnings target, said Jeff Windau, an analyst for Edward Jones & Co. in St. Louis. "It's an aggressive goal."

Construction Cycle

Earning more than $8 a share in 2012 "may not be as big a stretch as some believe," Ann Duignan, an analyst at JPMorgan Chase & Co. in New York, said in a report June 6. She estimates the company may deliver $8.69 a share.

"We believe the market is overlooking what could turn out to be the beginning of the next multi-year construction cycle in the U.S.," Duignan said. She rates the shares "overweight."

Oberhelman joined Caterpillar in 1975, the year he graduated with a finance degree from Millikin University in Decatur, Illinois.

He increased profitability at the company's engine unit, which he oversaw as a vice president from 1998 and then as group president since December 2001, said Eli Lustgarten, an analyst for Longbow Research in Independence, Ohio. The unit's operating profit as a percentage of sales rose to 12.9 percent in 2009 from 5.1 percent in 2001, according to Bloomberg calculations.

Caterpillar said June 1 it would buy Electro-Motive Diesel, a maker of rail locomotives, for $820 million. Two weeks later, Caterpillar said it would spend $700 million developing mining trucks and hydraulic shovels. It also plans to raise output in China and to build a factory in Brazil.

"Owens tends to be more cerebral," said Lustgarten, who rates Caterpillar shares "neutral." "Oberhelman will be more focused on operations and improving profit."