CAT_Equity Research

CAT (NYSE)Cisco Martinez

9 Lives, LLP Equity Research


• First established 1925 in California. Reorganized as Caterpillar Inc. in 1986• Global conglomerate with a multitude of acquisitions and joint ventures• New CEO in July 2010• Three principle business: Machinery, Engines, Financial Products• Sales spread across four global operating regions

• Based on Sales of $42.6 Billion USD, largest manufacturer of construction and mining equipment in the world

• One of the United States’ leading exporters

Company Overview


38.5%

24.7%

22.7%

14.1%

2010 Sales by Geographic Region

North America

Asia/Pacific

Europe, Africa, and Middle EastLatin America

65.2%

28.4%

6.4%

2010 Sales by Business Line

MachineryEnginesFinancial Products


• CAT competes in the Farm and Construction Machinery industry• Highly competitive global environment• Global recession cut demand in 2009• Key contributors to revenue: commodity prices, housing market,

financial market, government infrastructure spending

Industry Overview


Potential Entry

Low Low due to high capital requirements

Substitutes Low Customers highly dependent on specific products and technology

Supplier Power

Low Competitive steel industry with global span – China leading

Buyer Power Low Dealer network not concentrated: 50 US/138 outside US;182 countries and 3,475 places of business

Rivalry High Products sold worldwide to competitive markets with intense competition resulting in price discounting

Industry Forces Analysis LTM Stock Returns


• 2010 sales and revenues were 31% higher than in 2009

• Reported manufacturing costs improved $909 million from 2009

• Increased R&D in improved emission engines to meet regulations

• Improve product mix for higher margins

• Acquisitions:

Company Strategy

http://www.mwm.net/


Profitability and Risk: Key Data

Profitability: CAT

Gross Margin (TTM): 34.1%

Operating Margin (TTM): 11.5%

Profit Margin (TTM): 7.6%

CAT: ABOVE average profitability

Financial Strength: CAT

Quick Ratio (MRQ): 0.9

Current Ratio (MRQ): 1.4

Total Debt/Equity(MRQ): 2.6

CAT: BELOW average financial strength

Market Data

Current Price (4/15/2011): 107.21

52-week low: 54.89

52-week high: 113.93

Market Cap. ($M): 68,490

Shares Out. (M): 638.8

Beta: 1.77

Management Effectiveness: CAT

ROE (TTM): 26.74%

ROA (TTM): 4.03%

ROIC (TTM): 8.60%

Asset Turnover: 0.7

A/R Turnover: 2.8

CAT: ABOVE average management effectiveness

TTM=Trailing 12 MonthsMRQ=Most Recent Quarter


Profitability and Risk: Key Data

• MD&A reported Machinery and Engines debt-to-capital ratio reduced from 47.2% in 2009 to 34.8% in 2010

• No improvement in cash flows to liabilites

Ratio 2010 2007

Oper Cash Flow/Total Liabilities 9.7% 17.3%

Oper Cash Flow/Current Liabilities 24.4% 37.7%

COGS/Sales 71.3% 72.6%

• Cost improvement


Earnings Quality

• No major issues from changes in accounting principle, impairment losses, and extraordinary changes in cash flow not attributable to notes in 10-K

• 2009 LIFO liquidation decreased COGS $300M, increased profits $240M

• Receivables move steadily with revenues

• Economic downturn affected company ratios, but competitors performed similarly


Earnings Quality - Receivables

• Short-term receivables correlate with sales

• Long-term receivables affected by recession and low interest rates


Earnings Quality – Pension Benefits

• Pension underfunding reduced $2.2 billion

• CAT contributed $812 million of company stock to plan assets


Earnings Quality – Pension Benefits

• Pension assets primarily Level 1


Earnings Quality – Foreign Exchange Risk

• Foreign exchange risk


Financial Statement Forecast

• Revenue Growth Assumptions

• Summary Income Statement Data

2011E 2012E 2013E 2014E 2015EMachinery $35,210 26.8% $40,897 16.2% $44,692 9.3% $47,512 6.3% $49,424 4.0%Engines 13,468 11.3% 14,547 8.0% 15,298 5.2% 16,018 4.7% 17,091 6.7%Financial Products 3,317 21.9% 3,771 13.7% 4,073 8.0% 4,309 5.8% 4,507 4.6%Total $51,995 22.1% $59,215 13.9% $64,063 8.2% $67,839 5.9% $71,023 4.7%

Consolidated Results of Operations 12 Months EndedIn $ Millions, except Per Share data 12/31/2010 12/31/2011 12/31/2012 12/31/2013 12/31/2014 12/31/2015

Total sales and revenues $42,588 $51,995 $59,215 $64,063 $67,839 $71,023Total operating costs $38,625 $45,741 $50,852 $54,439 $57,082 $59,160Operating profit $3,963 $6,254 $8,363 $9,624 $10,757 $11,863

Profit $2,700 $4,154 $5,632 $6,528 $7,342 $8,137

Profit per common share $4.28 $6.45 $8.66 $10.19 $11.63 $13.09Profit per common share - diluted $4.15 $6.26 $8.41 $9.89 $11.29 $12.71

Cash dividends declared per common share $1.74 $1.84 $1.99 $2.15 $2.28 $2.42


Financial Statement Forecast (cont.)

• Summary Balance Sheet Data

• Summary Cash Flow Data

Consolidated Summary Statement of Cash Flow 12 Months EndedIn $ Millions 12/31/2011 12/31/2012 12/31/2013 12/31/2014 12/31/2015

Cash Flow from Operating Activities $2,987 $8,082 $10,506 $11,500 $12,850

Cash Flow from Investing Activities -$7,559 -$7,315 -$5,860 -$5,183 -$4,873

Cash Flow from Financing Activities $6,453 -$7 -$4,136 -$5,920 -$7,641

Increase (Decrease) in Cash & Short Term Invest $1,881 $760 $510 $397 $335Cash and Short Term Investments - Beginning of Year 3,592 5,473 6,233 6,743 7,141Cash and Short Term Investments - End of Year $5,473 $6,233 $6,744 $7,141 $7,476

Consolidated Financial Position 12 Months EndedIn $ Millions 12/31/2010 12/31/2011 12/31/2012 12/31/2013 12/31/2014 12/31/2015

Total current assets $31,810 $38,299 $42,799 $45,521 $48,195 $50,447Total assets $64,020 $75,788 $84,091 $89,112 $93,103 $96,017

Total current liabilities $22,020 $24,161 $26,251 $26,711 $26,736 $26,355Total liabilities $52,695 $60,062 $64,907 $64,899 $62,527 $58,432Total stockholders' equity $10,864 $15,288 $18,767 $23,817 $30,201 $37,228Total liabilities, redeemable noncontrolling interest and stockholders' equity $64,020 $75,788 $84,091 $89,112 $93,103 $96,017


Cost of Equity Capital

$86.31 10.07% 11.07% 12.07% 13.07% 14.07%3.00% $109.98 $93.49 $80.76 $70.66 $62.483.50% $115.38 $97.19 $83.37 $72.55 $63.864.00% $121.66 $101.41 $86.31 $74.64 $65.384.50% $129.07 $106.27 $89.63 $76.98 $67.065.00% $137.94 $111.93 $93.42 $79.60 $68.93C

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Valuation – Free Cash Flow to Equity

Cost of Equity 12.07%Long-Term Growth Rate 4.00%

1 2 3 4 5 52011 2012 2013 2014 2015 Continuing

Free Cash Flows from Operations $1,106 $7,322 $9,996 $11,103 $12,515Net Capital Expenditures -3,492 -3,734 -3,582 -3,437 -3,450Net Additions to Finance Receivables -4,073 -3,238 -2,150 -1,683 -1,412Debt Cash Flows 6,095 2,412 -1,787 -3,877 -5,199Free Cash Flows for Common Equity -$364 $2,762 $2,477 $2,105 $2,453

Net Income 8,462Increase in Assets -3,841Increase in Liabilities 2,337Free Cash Flows for Common Equity 6,959

PV of FCF for Common Equity -$325 $2,199 $1,760 $1,334 $1,388 $48,779

Total PV of FCF for Common Equity $55,134Shares Outstanding (millions) 638.8Share Value $86.31


Cost of Equity Capital

$94.45 9.07% 11.07% 12.07% 13.07% 14.07%3.00% $140.95 $101.86 $88.90 $78.58 $70.193.50% $149.15 $105.56 $91.51 $80.47 $71.574.00% $158.97 $109.78 $94.45 $82.56 $73.094.50% $170.93 $114.64 $97.77 $84.90 $74.775.00% $185.83 $120.30 $101.56 $87.52 $76.64C

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Valuation – Dividend Discount Model

Cost of Equity 12.07%Long-Term Growth Rate 4.00%

1 2 3 4 5 52011 2012 2013 2014 2015 Continuing

Dividend $1,205 $1,320 $1,404 $1,460 $1,525Less: Common Stock Issues -811 -515 -311 -247 -181Plus: Common Stock Repurchases 0 3,602 3,031 2,601 2,806Total Dividends to Common Equity $394 $4,407 $4,124 $3,813 $4,150

Continuing Cash Flow $6,959Divided by: Perpetuity with Growth Factor 0.0807Continuing Value at 12/31/2015 $86,233

Present Value $352 $3,509 $2,930 $2,417 $2,347 $48,779

Equity Value $60,334Shares Outstanding 638.8Value per Share $94.45


Key Assumptions by Technique Used

• Company guidance:– 2011 and 2012 revenues, 2011 R&D expense, 2011 capital expenditures

• Turnover ratios:– Current assets and current liabilities

• % of Sales:– Operating expenses

• Detail analysis:– PP&E, capital expenditures, depreciation, asset sales

• CAPM:– Cost of equity capital

• Other:– Excess cash flow used to repurchase shares and pay off debt

Cost of Equity CalculationRisk-Free Rate 3.41%Market Risk Premium 5.00%Beta 1.77Cost of Equity 12.26%


Conclusion

• Overall Opinion: SELL

• Key Risks Identified:– Business highly sensitive to global industry economic conditions– Rising input prices or shortages– Disruptions or volatility in financial markets could limit liquidity for the

Caterpillar, customers, dealers, and suppliers– Highly competitive environment could put downward pressure on pricing– Synergies implied with recent acquisitions may not be fully realized

• Current market price overestimates medium term (3-5 years) revenue growth and improvement in gross margin

CAT_Equity Research

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