Caterpillar’s recovery hopes on shaky ground

At Caterpillar’s annual shareholder meeting in Chicago last year, one questioner asked Jim Owens, chief executive, how the manufacturer got its name.

Mr Owens is likely to face tougher grilling at this year’s shareholder gathering on Wednesday. Last year, Caterpillar, the world’s biggest manufacturer of construction equipment and heavy-duty engines, was navigating relatively well through the US recession – thanks to its growth in international markets and the boost that strong commodity prices gave the energy and mining sectors in emerging economies.

The manufacturer, viewed as a bellwether of the US economy, depends on sales outside North America for more than half its revenue. Mr Owens boasted at the time that Caterpillar was on course to deliver record profits in spite of the US downturn.

When the recession went global and commodity prices tumbled, Caterpillar proved less able to defy economic gravity. In the first three months of this year, the company reported its first quarterly loss in 17 years. It has shed 26,000 jobs around the world in recent months, slashed executive pay by up to 50 per cent and cut its profit outlook in half as it braces for what Mr Owens recently called “the most significant percentage decline in our sales since the early 1930s”.

Nevertheless, at the company’s earnings call in April, Mr Owens suggested 2009 could mark the end of the global downturn, with a recovery beginning by next year. “The situation seems to be stabilising and we’re pleased to see commodity prices that have strengthened to levels that normally drive additional investment,” he said.

Investors may be wondering if the plain-speaking Caterpillar chief is not too optimistic. While the manufacturer will ultimately depend on international sales in areas such as mining equipment to return to its former growth, in the near-term it is looking to the US – still its largest single market – to pull it out of the mire.

Construction activity in the US shows little sign of co-operating. Robert McCarthy, an analyst at Baird, noted last month that Caterpillar “expects a US recovery by 2010, but non-residential construction spending only recently turned down and housing starts continue to decline”.

John Kearney of Morningstar in Chicago cautions that although a bottom may have been reached in terms of heavy-equipment sales, that does not imply meaningful growth is imminent.

“There may be a difference between reaching the bottom and getting a big upturn,” says Mr Kearney. “We could be close to a bottom, but the question is: do we just bounce along here or do we get some sort of activity where we get back up to more normalised production levels?”

Mr Owens, a member of President Barack Obama’s Economic Recovery Advisory Board and a friend of Ray LaHood, the US transportation secretary, has been critical of Washington’s $787bn stimulus plan, saying the portion dedicated to infrastructure was too small to offset the decrease in private-sector spending and puny compared with the investment in infrastructure contained in China’s economic stimulus plan.

He has been pushing for a second stimulus, without which, he has warned, the recovery of the US’s industrial sector will be slower.

Mr Owens has seen positive signs in China, with sales of heavy construction equipment returning. He can also point to a strong balance sheet, with $3.6bn cash on hand at the end of March. Market activity in Caterpillar share options suggests traders think its stock price is turning up.

Mr Obama touted his stimulus plan in Caterpillar’s home town of Peoria, Illinois, saying it might allow the company to start hiring again. However, if growth fails to return to the US construction sector, Mr Owens may be forced to trim further.

“Given their track record so far, the jobs cuts have not been enough,” says Mr Kearney. “If you were being conservative you’d have to be open to the possibility that there’s going to be some additional cuts going forward.”