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Stock Analyst Update

Caterpillar Beats Estimates, but Cautiously

U.S. equipment sales weak, but power business is coming on strong.

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Dow component Caterpillar (CAT) continued its recovery from a shaky 1999, reporting solid second-quarter results Thursday but warning investors against too much near-term optimism. The construction-equipment giant's earnings came in at $0.90 a share, 15% better than a year ago and $0.03 better than consensus estimates. This is Caterpillar's second straight quarter of improving profits, following a year of declines.

Despite its rising profits, Caterpillar's flagship North American construction-equipment business has suffered from declining sales and is expected to underperform for the rest of this year. At first glance this is somewhat surprising, given that Caterpillar is a cyclical company and the U.S. economy remains strong overall. But interest rates have been rising and housing starts have been sluggish, both of which are bad for Caterpillar. Management said Thursday that it expects earnings for the second half of the year to come in at the low end of estimates, mostly because of continuing fallout from higher interest rates.

Partially offsetting this weakness in its core business has been Caterpillar's distributed power-generation business, an area where it's quietly becoming a leader. Telecommunication and Internet-infrastructure companies are among the best customers for the type of small-scale, customized power generation that Caterpillar provides. As a result of the increasing numbers of firms in those areas, that business has been growing 25% annually, much faster than the rest of the company, and has also been more profitable. Management says it expects power generation to grow to 20% of Caterpillar's revenues from 10% over the next few years.

Caterpillar's stock has been taken a beating lately, dropping 40% from its highs of last fall. And the company's lukewarm outlook for the rest of the year means that its stock is unlikely to get out of the doldrums soon. However, if the firm continues to develop its noncore businesses as well as it has so far, Caterpillar could be a good stock to own for the long term.

David Kathman does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.