Caterpillar Answered 5 Burning Questions About China

Shares of Caterpillar fell 4.6% today, despite beating expectations and raising its EPS guidance.

The culprit: A warning in China.

The line from the earnings release that caught people's attention was:

We expect that sales in the developing countries will be lower than anticipated, with most of the weakness in China and Brazil.  Demand in Brazil is showing tentative signs of improvement, and we expect recent, sharp interest rate cuts will reinforce that trend.  Demand in China remained weak after the Chinese New Year, and we now expect the overall machine industry to decline slightly this year.  We expect the government will continue to ease economic policies further, but not in time to support significant recovery this year.  

Following up on that, the company took on the questions head on in the conference call.

Right off the bat, it answered 5 questions on China, per the transcript, via Seeking Alpha:

Now, before covering the 2012 outlook, I think now is a good time to talk a little more about China. Both the economy and the machine industry in China have been common themes over the past quarter, so I'll take a minute and run through what are likely your concerns. First, how is the decline in China's construction equipment industry impacting our sales? And the answer is, China's sales were down between the $250 million and $300 million in the first quarter compared with the first quarter of 2011, mostly related to excavators. To put that in perspective, China's sales were down--to put China's size in perspective, sales are a little over 10% of our total Asia-Pacific region, and around 3% of total Cat.

Second question is, 'How has machine pricing held up?', and the answer is, it's been relatively flat. Not much change versus a year ago. That said, there is too much finished goods inventory in China on the ground today, both ours and our competitors’. Pricing in China has been largely rational, and we haven't changed our total company 2012 price realization outlook.

Now, speaking of too much inventory on the ground in China, that's why this year we're going to divert some of the excavators that we make in China to other regions of the world where we're very tight on supply. We'll export probably around 20% of China's 2012 midsize excavator production this year.

So, the third question, 'What are our expectations for sales in China for the full year of 2012?' And the answer is, we have taken our forecast down, and we expect the full year will be modestly negative versus 2011, with the decline coming mostly in the first half of the year. Now, that doesn't mean that we're banking on a major increase in the second half. It's mostly because excavator sales were already declining in the second half of 2011. While we do expect the construction industry to improve moving forward, there's too much inventory in the channel and it does need to be sold down in 2012.

Fourth question, 'How has China's slowdown in overall economic activity impacted our global mining business?' And the answer is, global mining has remained very strong. Our worldwide order backlog for mining continued to increase in the first quarter. Remember, slower growth in China does not mean their economy is shrinking. In fact, it's growing faster than most of the world. Our forecast is for economic growth in China this year of over 8%, and that's driving continued growth and energy needs and consumption of most commodities. As a result, most commodity prices remain high by historic standards, and mining companies are in generally good shape and continuing to invest.

Question five, 'Has the recent weakness in China construction equipment changed your capacity expansion plans?' The answer is no, but with a caveat. We continue to be a strong believer that China is a major, long-term growth opportunity. It's a very large economy with significant development and growth still ahead. It's the world's largest market for construction equipment, and we intend to be the leader. So, in that context, no. Our build out in China is continuing. The caveat is that our excavator expansion is staged, and we can adjust the timing of capacity additions if we need to.

So in summary, is China down in 2012? Yes. Will it recover? In our opinion, absolutely. The long-term future for China looks very good. Do we need to be prepared for the next round of growth? You bet we do.