On Monday, Caterpillar (click ticker for report: ) announced all-time records for annual revenue and profits. The top line advanced 10% to $65.9 billion for the year, while profit per share jumped 15% to $8.48, even with the impact of the goodwill impairment charge related to accounting misconduct at Siwei. Though fourth-quarter performance was lower than that of the year-ago quarter, we were quite satisfied with Caterpillar’s ability to navigate the difficult economic climate during 2012.
The company’s outlook for 2013 wasn’t too shabby either, with revenue expected to be as high as $68 billion, translating to earnings per share of $9 (at the high end of the guided range). Though we plan to make a number of tweaks to our valuation model for Caterpillar, we don’t expect them to result in a material change to our fair value estimate.
Caterpillar is watched very closely because the firm provides one of the most detailed economic outlooks in its earnings press release. Though we publish our view on the economic environment in our Best Ideas Newsletter each month, it’s always good to see what Caterpillar’s management has to say. The following is an excerpt from Caterpillar’s fourth-quarter earnings release:
2013 Economic Outlook
World economic conditions, while improving, are still relatively weak. Indicators improved in many countries in late 2012, suggesting better prospects for economic growth in 2013. In the large economies, we expect some improvement in the United States and China, and a continuation of economic uncertainty in Europe.
Overall, we expect the world economy will begin the year with weak growth and improve as 2013 unfolds. We anticipate overall world economic growth of at least 2.5 percent—a small improvement from our estimate of 2.3 percent for 2012.
Key points related to this outlook include:
• Central banks reduced interest rates over the past 15 months and some further cuts are possible. With inflation low, we expect there will be little pressure to tighten policies in 2013. With the exception of Europe, monetary easing will likely offset much of the impacts of tighter fiscal budgets. Overall, we expect economic policies will be the most favorable for growth since 2010.
• One sign lower interest rates are working is that both manufacturing and service purchasing manager indices improved over the past few months. Both ended 2012 at values that signal growth.
• Another positive sign is that metals prices have improved from their mid-August 2012 lows, and fourth-quarter data for China indicates increased imports of coal, iron ore and copper.
• We expect economic growth will improve demand for most metals in 2013, and average metal prices in 2013 will be higher than 2012. We expect copper will average $3.75 per pound in 2013 and China port iron ore $135 per ton. Those prices will likely be attractive for production and investment.
• Coal prices also improved in late 2012, but are currently 5 to 20 percent below a year ago. We expect that continued relatively low prices for U.S. natural gas will keep pressure on coal prices in 2013. We are expecting Central Appalachian coal will average about $65 per ton, slightly higher than $63 per ton in 2012.
• Average interest rates in developed economies are already below lows reached during the financial crisis, so prospects for lower rates are limited. However, some central banks are adding liquidity in their financial systems as a way to increase economic growth.
• Growth in the developed economies will likely be slow in early 2013 and improve throughout the year. We expect economic growth will average about 1.5 percent this year, slightly above 2012.
• Financial conditions have improved in the United States in response to past U.S. Federal Reserve easing. Credit spreads are down, bank capital ratios are near record highs and banks are easing lending standards. The Fed’s plan to increase monthly bond purchases to $85 billion will likely help ease financial conditions and increase lending. We expect the U.S. economy to grow at least 2.5 percent in 2013.
• The underlying fundamentals that support U.S. housing construction continue to improve. Housing affordability is better, the inventory of unsold homes has come down significantly over the past few years and home prices have begun to recover. As a result, we expect housing starts to exceed 1 million units in 2013, which would be the highest year since 2007.
• Nonresidential building construction in the United States improved in 2012, and we expect further growth in 2013. Vacancy rates are down, and property prices are up, both trends that we expect to continue. Infrastructure construction is likely to be higher as we expect state and local government spending to increase in 2013.
• Interest rates in the Eurozone are at record lows, and credit spreads are improving. However, economic policies are less aggressive than in Japan and the United States. As a result, we expect growth in the Eurozone will struggle to match 2012, and we expect that construction activity will decline for the sixth consecutive year, reaching the lowest level since at least 1990.
• We expect the new Japanese government to ease monetary policy and increase infrastructure spending. We expect Japanese economic growth near 1 percent in 2013.
• Developing economies have been lowering interest rates for more than a year, and average rates are close to levels reached during the financial crisis. Low interest rates will likely contribute to better growth. We expect that, in the aggregate, developing economies will grow at more than 5 percent in 2013.
• China’s economic slowdown in 2012 unfavorably impacted construction in China and world prices for metals, coal and oil. In the second half of 2012, the Chinese government accelerated credit growth and infrastructure spending, and, as a result, economic data in the fourth quarter improved. Our outlook assumes the Chinese government will maintain pro-growth policies throughout 2013. We expect economic growth near 8.5 percent and a more favorable environment for construction and commodity demand.
• Most other Asian countries also lowered interest rates in 2012, and we expect faster economic growth in 2013 than 2012. Better economic growth is expected to be positive for construction.
• Interest rates in Latin America have also been declining and are at record lows in Brazil. We expect lower interest rates, higher commodity prices and better world economic growth will improve economic growth in the region to about 4 percent in 2013. We also expect construction activity to improve as a result of better economic growth and large infrastructure programs.
• Most countries in Africa/Middle East and CIS have maintained economic policies close to those adopted in the financial crisis, and, as a result, growth has generally been sustained. We expect pro-growth policies will continue throughout 2013, allowing about 4-percent economic growth in Africa/Middle East and in the CIS.
Economic Risks
• Economic policies became more pro-growth in 2012, and, as a result, recent economic data has been more favorable. Overall, we expect policies to become even more stimulative, so upside to our outlook is possible. As in the past, we are concerned that central banks will reverse policies too early once better economic growth becomes apparent.
• A downside risk is Eurozone growth lagging behind the rest of the world. As the disparity becomes more evident, concern about the Eurozone economy and its currency could return.