Continued robust demand for Caterpillar's heavy equipment boosted the company's second-quarter profits by 44 percent, but higher costs and cautious comments about China's economy sent shares sliding Friday.
The company even bumped up its sales outlook for the year. Still, cost increases — mostly related to its recent acquisition of mining equipment maker Bucyrus — will prevent rising sales from boosting profit more than previously expected.
Caterpillar's quarterly profits fell short of Wall Street estimates for the first time since the recession ended, and its shares tumbled as much as 10 percent in the morning before recovering in the afternoon to trade about 5 percent down.
Many investors that were very optimistic about Caterpillar appeared to pause and reassess the prospects for months ahead, said Edward Jones analyst Jeff Windau, who believes Caterpillar still has strong long-term growth potential.
"There's a lot to digest in this quarter," Windau said.
The Peoria, Ill., company said it generated $1.02 billion net income, or $1.52 per share. That's up from $707 million, or $1.09 per share, a year ago.
But the Bucyrus acquisition cut into second-quarter profit and weighed down Caterpillar's outlook. Without it, quarterly profit per share would have been $1.72.
That was still below Wall Street expectations of $1.74, according to a poll of analysts by FactSet. And Credit Suisse analyst Jamie Cook said that many investors were expecting Caterpillar to report earnings per share above $2.
Revenue grew 37 percent to $14.2 billion, easily topping Wall Street estimates.
Caterpillar predicts 2011 sales between $56 billion and $58 billion with Bucyrus. Previously, it predicted sales between $52-and-$54 billion.
However, overall sales growth that would have added 50 cents to per-share earnings this year have been offset negatively by about $700 million of costs associated with the Bucyrus deal, which were about $200 million higher than expected.
Caterpillar lost about $150 million on interest rate swap contracts it bought to make sure it would be able to secure financing for the $7.6 billion Bucyrus acquisition at low rates. And inventory costs related to the deal also hurt Caterpillar's profit by $250 million.
Even though it lost money on the interest rate swaps, Caterpillar was able to finance $5.5 billion of the deal's price at an average rate of 2.65 percent.
And confidence remains high in the mining sector after Caterpillar's big investment. It predicts that mining companies will increase capital spending by more than 50 percent this year to satiate the burgeoning demand for commodities.
And company officials believe the Bucyrus acquisition will provide a significant long-term boost because Caterpillar now has a full line of mining equipment.
"I really can't think of a more attractive industry than mining — not for the next two or three years — but really for the next 20 to 30 years," said Steve Wunning, who oversees Caterpillar's mining equipment business.
Caterpillar's earnings are an indicator of the health of the global economy because it is the world's largest maker of construction and mining equipment. When the economy is growing, Caterpillar sells more of its backhoes, mining equipment and engines.
And like everyone, from consumers to other industrial manufacturers, Caterpillar is wrestling with higher costs.
Costs grew 34 percent to $12.6 billion for Caterpillar in the quarter as steel, freight and wage costs all increased. The company said its higher outlook triggered $85 million in incentive pay costs.
The aftermath of the tsunami and earthquake in Japan cost Caterpillar about $200 million in sales and reduced net income by nearly $60 million, or about 6 cents per share.
Caterpillar Chairman and CEO Doug Oberhelman said the growth in China has slowed this year because of government efforts to limit inflation there, but it continues to grow at a strong pace and deliveries were up in China during the second quarter. He said the slowdown in China is not a bad thing because Caterpillar will be able make sure it doesn't overbuild manufacturing capacity in China.
"The hot market we saw there in '09, '10, and '11 was just too hot; we all knew it. So a slowdown for us I think is healthy," Oberhelman said during a conference call.
Plus, any excess capacity in China can be exported to India and other strong markets. Caterpillar expects strong growth to continue in developing countries in Asia, Latin America, the Middle East and Africa. So robust sales of the company's construction and mining equipment is expected to continue.
Overall, the company predicts 3.5 percent growth in the global economy in 2011, down from 3.9 percent last year.
Oberhelman said the economic recovery in the United States remains weaker than expected, but the company is still predicting moderate U.S. growth, especially once the nation's leaders agree on trade policy and the debt limit. Plus, American construction firms are starting to replace aging equipment.
Oberhelman said he believes the current lack of confidence in the U.S. business climate is the biggest impediment to a stronger recovery.
"Lack of clarity on a U.S. deficit reduction plan, trade policy, regulation, much needed tax reform and the absence of a long-term plan to improve the country's deteriorating infrastructure do not create an environment that provides our customers with the confidence to invest," Oberhelman said. "We're confident that as a country we'll eventually get it right, and we're positioning Caterpillar to be ready when we do."
Caterpillar expects to continue hiring throughout 2011 as it expands production to meet demand, and the company still plans to spend about $3 billion on capital improvements this year.
Company shares fell $5.90 to $105.70 in afternoon trading.