Value Line is regarded as the best independent research available. More than just recommendations, Value Line provides the rationale behind its picks for greater understanding.
- Don D., California
Dow 30 Profile: Caterpillar Inc.
The Caterpillar Tractor Company, forerunner of today’s Caterpillar, Inc. (CAT - Free Caterpillar Stock Report), was formed in May 1925 from the merger of competitors C. L. Best Gas Tractor Company and Holt Caterpillar Company. Both of those concerns, meanwhile, had been involved in producing farm equipment, especially in the central valley of California, and later in the Midwest, since the latter half of the 19th Century.
Two Companies Strive to Build a Better Tractor
Steam tractors in the 1880s and 1890s were very heavy and often became stuck in the soft, muddy farmland of the San Joaquin Delta near Stockton, California. Benjamin Holt, of the Stockton-based Holt Manufacturing Company, hit upon attaching wide wooden planks, chained together, around (and later, instead of) the wheels of a tractor to form a continuous track that would prevent the vehicle from sinking in the earth. Holt acquired a patent for his vehicle in 1907, though he never successfully established his ownership of the “Caterpillar” name. In 1910, Holt opened a subsidiary in East Peoria, Illinois, called the Holt Caterpillar Company, to produce the new machines. In two years, the plant grew from 12 to 625 employees, and was exporting tractors to Canada, Mexico, and Argentina.
Clarence Leo Best, meanwhile, was Holt’s major competitor, and his C. L. Best Gas Tractor Company had a similar track-laying tractor, called the Best Model 60 “Tracklayer”. Best and Holt fought each other over patent and trademark infringement, and over contractual disputes, for years.
War Transforms the Competitive Landscape
During World War I, the Holt Caterpillar Company supplied Britain with heavy, tracked artillery vehicles, precursors of the modern tank. At the same time, the C.L. Best Gas Tractor Co., heavily subsidized by the U.S. government, gained major market share in the farming sector with its Model 60 Tracklayer. Both companies thus grew rapidly in the period from 1910 to 1918.
After The Great War, however, both companies ran into trouble. Holt Caterpillar struggled in its transition from a military supplier to a commercial supplier, especially because it had reoriented production to military uses, but its military tractors were unsuitable for the farming market. It was saddled with a large inventory of undesirable equipment. Struggling, the company took on large debts. C. L. Best, meanwhile, had financed its wartime expansion with debt, and the postwar depression of 1920-1921 put a severe strain on the company. Finally, Harry Fair, of the San Francisco bond brokerage company Pierce, Fair & Company, recommended the two companies merge, which they did in 1925, to form the Caterpillar Tractor Company. Benjamin Holt had died in 1920, but Clarence Best served as Chairman of Caterpillar’s Board until he died in 1951.
Rapid Growth at the Combined Company
Caterpillar now offered five tracklaying tractors. In the new company’s first year, sales were $13 million; by 1929, they had grown to almost $53 million. During the Great Depression, government infrastructure spending rose, and the company embarked on a notable expansion. Its equipment helped build the Hoover Dam, the Grand Coulee Dam, the Bonneville Dam, the Mississippi River levee system, the Chesapeake and Delaware Canal, and the Golden Gate Bridge, among many other projects.
World War II brought more opportunity, as Caterpillar products were used by the U.S. Navy’s Seabees to build airfields and other military infrastructure for the war effort in the Pacific. Between 1942 and 1945, the company, operating seven days a week, doubled its workforce and produced some 51,000 tracklayer tractors for the military.
Postwar Boom Makes Caterpillar a Multi-National Powerhouse
The postwar boom was also a boon for the company, as its equipment was used to rebuild Europe, construct some 70,000 miles of highway throughout the United States as a part of the federal highway system, and build the St. Lawrence Seaway in a joint U.S.-Canadian effort, among many other projects, domestic and international.
In 1950, the company established its first significant overseas operation, Caterpillar Tractor Co. Ltd, in the United Kingdom. The company expanded to Brazil in 1960, among other locations. Its products have been involved in numerous, major international construction projects.
Near-Bankruptcy in the 1980s and Labor Unrest in the 1990s
As a large manufacturing company, Caterpillar has had to carefully manage operations in anticipation of upturns and downturns. The 1981-1982 recession was particularly challenging and severely strained corporate finances. The downturn led to a dramatic decline in equipment demand, which, combined with competition from Japan’s Komatsu, resulted in Caterpillar losing $1 million a day at one point.
The difficulties forced the company to slash production and begin laying off workers, which hurt relations with influential labor unions. The United Auto Workers (UAW) and Caterpillar engaged in a series of disputes, including a then-record long 17-month UAW strike in 1994-1995. In response to the labor disputes, Caterpillar began outsourcing parts production and warehousing operations. It also began moving some manufacturing facilities to southern states with laws less favorable to organized labor.
The company was restructured as Caterpillar, Inc. in Delaware in 1986.
Efficient Operations a Pathway to Future Profits
In recent years, the machinery giant has sought to maximize its operating performance utilizing various efficiency and cost-control methods. One recent, significant example of this effort is the Caterpillar Production System (CPS) with Six Sigma. CPS, similar to the Toyota Production System, organizes manufacturing and logistics with the aim of optimizing the order-to-delivery process. The system is largely based on just-in-time inventory management and lean manufacturing principles.
Today, Caterpillar sells equipment in 200 countries and territories, and has 94 plants in the U.S. and another 84 facilities overseas. The company has a global network of some 188 dealers, about 50 of which are domestic. Employment is around 104,500 (45%, U.S.; 12%, unionized). Sales and revenues in 2010 were about $42.6 billion (68% outside the U.S.); order backlog was $18.7 billion. Business lines are divided into three general categories, Machinery, Engines and Financial Products.
The Machinery division (65% of 2010 revenues) designs, produces, and sells products, such as track and wheel loaders and tractors, excavators, backhoes, skid-steer loaders, off-highway trucks and underground mining equipment, to the global construction, road building, mining and forestry markets. This division also has a logistics service business and a railroad equipment remanufacturing & service operation, both of which help to reduce overall sales and earnings volatility.
The Engine division (29%) manufactures diesel-powered engines for use in Caterpillar machinery, as well as in power generation, railroad, marine, construction, industrial and, among others, agricultural applications. Additionally, the division offers engine-remanufacturing services. Reciprocating engines and turbines are key products.
Financial Products (6%) provides financing and insurance services to customers and dealers. Importantly, when global credit markets are tight, the finance arm facilitates machinery and engine sales to financially sound customers.
The company has a number of important competitors, including Komatsu, Volvo, CNH Global (CNH), Deere (DE), Hitachi (HIT), Terex (TEX), and Doosan Infracore, in the machinery market; and Cummins (CMI), Tognum, General Electric (GE), Siemens (SI), Wartsila, MAN SE, Mitsubishi Heavy Industries, Kawasaki Heavy Industries, Rolls Royce Group, Generac (GNRC) and Kohler, in the engine segment.
With construction spending declining in the developed world, Caterpillar has prioritized moving into developing markets for some years. The company built a facility in Russia in 1999 and in the People’s Republic of China (PRC) in 2009. Management reports a number of expansion plans in the PRC especially, as it expects that much of the construction demand over the coming 10 to 20 years to come from the Asia-Pacific region. In the United States, Caterpillar continues to work to reduce costs, moving production to lower cost facilities in North Carolina and Texas.
The company typically spends 4%-5% of revenues on research and development (R&D); in recent years, much of this expenditure has been dedicated to research on reduced emissions engines. R&D likely increased about 12% in 2011, to $2.5 billion.
Most dramatically, Caterpillar plans to expand its markets. In late 2010, it moved into the booming mining and metals area with its splashy $8.6 billion announced buyout of Bucyrus International. The acquisition should go a long way toward increasing Caterpillar’s exposure to the commodities market.
From 1992 to 2010, Caterpillar outperformed most of its peers, producing a 15.5% average annual total return for shareholders. The company intends to maintain industry leading total stockholder returns by achieving a 15%-20% compound annual growth rate in share earnings. We expect sales and revenue to power that growth, rising from some $42.6 billion in 2010 to $65 billion-$70 billion by 2012. Emerging markets (Brazil, Russia, India, China) will play a key role in this growth. The acquisition of Bucyrus, and the company’s rapid expansion in China augur well for its ability to meet its ambitious goals.
All told, CAT shares are stable, but cyclical. Investors wishing to gain exposure to the next infrastructure spending cycle would do well to consider this Dow-30 blue chip.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.