Caterpillar Inc. (NYSE: CAT), the world's largest maker of construction and mining equipment, is expected to report strong second-quarter profit as resurgent sales of construction machinery in the U.S. and ongoing global demand for mining equipment offset weakening sales in Europe, China and Brazil. The impact of acquisitions will also play a part.

The Peoria, Ill.-based company enters the earnings announcement season with strong revenue momentum. The company has averaged year-over-year revenue growth of 34 percent over the last four quarters.

A lot of the story probably continues and North America is kind of the growth driver right now, said Morningstar Inc. analyst Adam Fleck.

Caterpillar Inc. (NYSE: CAT), which reports earnings Wednesday before markets open, is likely to book a profit of $2.28 a share on revenue of $17.11 billion, based on the average estimate of analysts surveyed by Thomson Reuters. In the same period a year earlier, EPS was $1.52 on $14.23 billion in revenue.

Over the past month, the consensus estimate has dropped from $2.33.

Caterpillar didn't give quarterly guidance but raised 2012 annual earnings while maintaining sales and revenues outlook in April. Caterpillar now expects earnings for the year to be about $9.5 per share, at the middle of the sales and revenues outlook range of $68 to $72 billion. The previous profit per share guidance was about $9.25.

The outlook for 2012 would represent the highest sales and revenues and profit in Caterpillar history, exceeding last year's record results, the company said in an April statement.

While the Street is looking for a 50 percent jump in EPS, Fleck noted that the figure is getting a boost from acquisitions and that investors should focus on the underlying trend.

Given the fact that the Bucyrus acquisition wasn't completed until July of 2011 and the acquisition of MWM wasn't completed until last November, Caterpillar will be getting some growth from that just because the comparable period didn't have it, Fleck said. So that's going to make the growth rate look pretty good.

We are going to be watching the underlying growth rates and the underlying incremental margins, though it becomes difficult to peg those numbers down exactly with all the acquisitions going on, Fleck added.

Excluding the impact of acquisitions, Fleck said he would still expect Caterpillar to record positive profits and margins that are a little better than last year. However, he warned that a lot of that hinges on what happens in Europe, which is sort of a big wild card.

Analysts expect Caterpillar, a bellwether of the global economy, to remain cautiously optimistic and reiterate its guidance.

As far as guidance, I think they'll probably remain cautionary, Fleck said. I wouldn't expect them to come out and be overly bullish at this point.

William Blair & Co. analyst Lawrence De Maria holds a more optimistic view.

We expect second-quarter earnings to be above consensus estimates, De Maria wrote in a July 9 note to clients. Although there are pockets of weakness, we expect the second quarter to be relatively solid and the full-year guidance to be left intact.

Caterpillar dealer statistics and production levels have been mostly supportive and we still have confidence in the company's full-year outlook, De Maria added.

Caterpillar has beaten estimates for the past three quarters. In the first quarter, Caterpillar reported record-breaking profit of $1.59 billion, or $2.37 a share - a 29.5 percent jump from $1.23 billion, or $1.84 a share the year earlier, and handily topped analyst expectations. Revenue rose 23.4 percent to $15.98 billion, from $12.95 billion.

Backlog grew to $30.7 billion in the first three months of 2012, from the $29.8 billion at the end of 2011. The backlog is probably going to shrink in the second quarter, but that's not necessarily a bad thing, Fleck said.

The biggest backlog they are carrying is on the mining side, just because of their capacity constraint, Fleck said. They would prefer not to operate with that backlog because it means they are not producing to their customers yet.

Caterpillar competes with machinery makers such as CNH Global NV (NYSE: CNH), Deere & Co. (NYSE: DE), Joy Global Inc. (NYSE: JOY), Cummins Inc. (NYSE: CMI) and Astec Industries, Inc. (Nasdaq: ASTE).

Replacement Needs

Caterpillar retail sales demonstrated continued strength during May, with machines generating double-digit year-over-year growth for the 25nd consecutive month, according to the latest data available.

Replacement demand in North America is still strong and utilization rates at rental agencies are pretty decent, Fleck said. Given that both residential and commercial constructions continue to increase here in the first part of the year, it seems like activity has picked up, which would necessitate more equipment.

The average age of machines in dealer rental fleets was at a historically high level in 2011. While that number has come down to 48.9 months in May of 2012, from a high of 53.3 months in February 2011, the utilization rates in the U.S. are still higher than ever and Caterpillar expects U.S. construction equipment replacement to maintain its momentum.

We are coming off such a low base, so I think the replacement demand is likely to continue for some time here, Fleck said. These companies have let their equipment age pretty dramatically and there needs to be some replacement.

Low interest rates and small improvements in construction spending should encourage replacement demand in North America.

U.S. companies borrowed more to buy equipment in May of 2012 than a year ago, as they replaced worn-out equipment after deferring such activity during the U.S. economic recession in 2008 and the subsequent sluggish recovery, data released by the Equipment Leasing and Finance Association showed.

Companies financed $6.2 billion of new equipment last month, up from $5.6 billion in the year-earlier period.

Mining Demand

Mining equipment accounts for about a third of Caterpillar's total revenue.

Caterpillar noted that mining remained strong in every region except for U.S. coal, which is not a big percentage of Caterpillar's business.

While mining remains robust overall, U.S. coal production is an area that has recently weakened, Mike DeWalt, director of investor relations at Caterpillar told analysts during an April conference call.

Recently published electric power data for April show that, for the first time since the U.S. Energy Information Administration began collecting the data, generation from natural gas-fired plants is virtually equal to generation from coal-fired plants, with each fuel providing 32 percent of total generation.

Five years ago, coal captured 50 percent of net generation and natural gas was only a little more than 20 percent.

Railroad operator CSX Corp. (NSYE: CSX), a big mover of coal from mines to seaports, confirmed the decline in coal shipment during the company's second-quarter earnings release last week. Coal accounts for more than one-fourth of CSX's revenue, and shipment volumes of that were down by 37 percent.

Competitor Joy Global Inc. (NYSE: JOY) cut its full-year guidance on May 31 citing mild winter weather and competition from cheap natural gas, which have left U.S. coal producers with large stockpiles.

Roughly 5 percent of caterpillar's total revenues are generated from U.S. coal, including Bucyrus, which mainly focuses on the U.S. coal market.

So for US coal, we have seen some weakening, but in the context of worldwide mining it's not much, DeWalt said.

Moreover, Caterpillar's lead times are extended in mining equipment and the company is quoting orders out to 2014.

What I can say, if you look at coal, iron ore, and copper -- and we watch this very closely -- is that the prices today are significantly above -- and even though they have come down -- they are significantly above the threshold price where they begin to say we shouldn't invest, we shouldn't expand, we shouldn't open up another mine, Steve Wunning, Caterpillar group president with responsibility for Resource Industries, said at the Raymond James Infrastructure & Construction Conference in May.

And so given that, we feel like it's -- that the outlook is positive, this year is a growing year, Wunning added.

While Bucyrus is not immune to the decline in commodity prices, there's synergy to be captured.

With the acquisition of Bucyrus, Caterpillar can now address 90 percent of the market, compared with 25 percent before, according to a June management call. And Caterpillar's competitors can only address 50 percent of the market.

Caterpillar has alliance agreements with about 15 of the world's largest mining companies, and these customers get better pricing as they increase the size of the purchase, Ann Duignan, an analyst at JPMorgan Chase & Co., wrote in a May 25 note. She rates Caterpillar a BUY with a price target of $132 for the year.

Caterpillar will leverage this going forward as it provides a 'win' for both parties and is at the core of its rationale for acquiring Bucyrus, Duignan said.

The area that Bucyrus has always struggled in was aftermarket sales, which wasn't as strong as Joy Global's is. As a result, Bucyrus's margin was a little bit lower. So Caterpillar has the opportunity to increase that margin, which could offset some of the weakness in U.S. coal, according to Fleck.


While analysts in general expect Caterpillar to maintain its bullish guidance, recent signs suggest that Caterpillar might follow its peers and cut its full-year outlook when it reports earnings on July 25.

I think our view is this year the U.S. GDP is going to be around 3 percent, DeWalt of Caterpillar said in May.

However, the U.S. economy only grew at 1.9 percent in the first quarter and is expected to show a tepid 1.4 percent growth in the second quarter this Friday. Many economists believe the third quarter could be even worse.

Moreover, a cooling Chinese economy is also eating into U.S. companies' profits.

For China, the entire industry is somewhat suffering at this point, Fleck said, referring to the Chinese excavator market. We are looking at 14 straight months now of year-over-year declines for excavator sales.

China's economy expanded 7.6 percent last quarter from a year earlier -- the weakest growth in three years and the sixth straight deceleration.

The Chinese government's measures to cool an overheated housing market have also weighed on consumer and industrial demand.

Sany Heavy Industry Co., LTD (SHA: 600031), China's biggest maker of excavators, lowered its sales forecast for the equipment citing lower demand.

Excavator sales may increases 10 percent this year, slower than a previous target of 40 percent, Vice Chairman Xiang Wenbo said in a July 11 interview with Bloomberg.

Caterpillar's rival Cummins Inc. (NYSE: CMI) lowered its full-year revenue outlook for 2012 and now expects 2012 revenues to be in line with 2011, compared to the company's previous guidance of an increase of 10 percent, according to a July 10 statement.

Caterpillar's sales in China fell between $250 million and $300 million in the first quarter, pushing the company to export to other countries a large share of the equipment it made in China. We are introducing programs inside China to work with dealers to get some of that inventory in the hands of customers, Caterpillar Chief Executive Doug Oberhelman said during the first quarter earnings conference call.

Caterpillar plans to move about 2,000 machines over the next few quarters to Turkey, the Middle East and Africa, which, when coupled with planned reduced production levels, should result in more normalized volumes next year, according to De Maria.

In China, the second quarter is usually a pretty big sales quarter, so Caterpillar will usually build inventory ahead of that, Fleck said. But that strong sales period never really came about. And at the end of the first quarter, they are kind of stuck with some extra inventory.

China's excavator sales volume year-over-year growth rate remained in negative territory in June, down 19 percent to 8,627 units. However, the declining pace narrowed from a 24 percent year-over-year slump in May and 42 percent in April, according to a note published by Barclay's Capital on July 12.

Caterpillar also once again outperformed the industry, with excavator volumes down only 12 percent year-over-year, and market share of locally produced excavators increasing to 7.1 percent in the month, compared to year-to-date market share of roughly 6.0 percent.

So far this year, the Chinese excavator market is down 38 percent. About 40 percent of industry sales typically occur during the spring selling season, and even with moderating declines in the second half, the magnitude of the decrease this year, will still be significant.

Stock Performance

Caterpillar said in June that its board voted to increase the quarterly payout by 13 percent.

Investors are still waiting for the turn in China and Brazil, and if sentiment toward these economics improves, capital goods stocks will significantly outperform the broader market.

Shares of Caterpillar Inc. (NYSE:CAT) closed up 0.78 percent, to $81.58 a share in Monday's session. So far this year, the stock has lost 10 percent.