What's Driving Caterpillar's Earnings

Caterpillar (NYSE: CAT  ) is the world's largest manufacturer of heavy equipment for construction, mining, and infrastructure development, and as such the company's results have a lot to tell investors about the state of the global economy. After lowering its revenue outlook for 2015 in September, Caterpillar is due to report earnings before the bell on Oct. 22. Here's what to watch for.

Economic outlook
Caterpillar's cut to 2015 numbers came only shortly before Cummins (NYSE: CMI  ) , the world's largest independent developer of diesel engines, lowered its own guidance for 2013. If Caterpillar fails to beat its earnings estimates, which analysts polled by Thompson Reuters peg at about $2.22 per share, investors may take it as a sign that fellow bellwether Cummins was right to be pessimistic on a shorter time frame.

Caterpillar has outlined a detailed plan to stay profitable even in a recession, although CEO Doug Oberhelman explains that the company is not necessarily expecting a recession before 2015; rather, it's just prepared. However, if the company appears to be reining in capital expenditures, especially in major growth markets like China, that might be a clue that Caterpillar's outlook has soured and the company is battening down the hatches in accordance with its recession plan.

Caterpillar's results could also contain some very bright indicators. Big expenditures in emerging markets would signal that Caterpillar remains bullish on global growth and is investing in capacity to capture that market. Strong sales of replacement parts and new equipment in its home turf of North America would offer yet another data point that the American housing recovery is real and under way, as homebuilders spend to maintain or replace aging construction machinery.

Execution
For Caterpillar shareholders, earnings matter not only as clues about the state of the economy, but also as signs of the health of their investment. Capital expenditure in China is all well and good, but investors will want to see that Caterpillar is making some headway in its battle to unseat Japanese rival Komatsu as the incumbent market leader in China.

For the time being, market share and revenue are probably more important in China than profitability, because of Caterpillar's "Seed, Grow, Harvest" business model. In other markets, Caterpillar has sown "seeds" by making quality equipment, "grown" its business by rolling out an extensive network of dealers and servicers, and finally "harvested" the high-margin aftermarket business of supplying replacement parts, maintenance services, and dealer support. Caterpillar is still in the "grow" phase of its Chinese operation.

Investors should also look to see that Caterpillar's recent spate of acquisitions is integrating well. Improving operating margins would be a great sign, while taking substantial acquisition-related charges indicate that Caterpillar is having a problem assimilating its smaller buyouts.

More than anything, watch to see whether Caterpillar beats analyst estimates yet again, as it has every quarter for the past year. It's notable that even Caterpillar's "lowered" earnings guidance is far higher than analysts believed possible in 2009. Because of its market-leading position and excellent brand reputation in a critical industry, it's hard to keep Caterpillar down for long.

Whether you're looking to invest, or wondering whether it's time to cash in your shares, The Motley Fool's premium research report on Caterpillar can help you break down how the company maintains its competitive advantage, as well the headwinds the company is facing in continuing its winning streak. This report comes complete with a full year of analyst updates, so click here to get your copy now.

Fool contributor Daniel Ferry owns shares of Caterpillar. The Motley Fool owns shares of Cummins. Motley Fool newsletter services recommend Cummins. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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