Story Stock – 04/20/2005

Caterpillar (CAT) $89.68 +4.73 (+5.6%) Caterpillar’s results today were absolutely stunning, particularly since you rarely see fully mature, extremely large companies whose market is also mature deliver such an incredible upside surprise. Not only did Caterpillar beat revenue estimates by $1.1 billion ($8.3 billion vs $7.2 billion estimate) and deliver a 20% earnings surprise, they significantly raised guidance for the full 2005 year. The guidance is for a 16-18% revenue increase over 2004 and EPS to be up 35-45%.

The current (before today’s report) estimates for CAT for the 2005 full year are: $32.3 billion (7% over 2004) and EPS of $7.32 (27% over 2004). Using the middle of the percentage range given by CAT for 2005 results in guidance of $35.5 billion for revenue and $7.88 for EPS.

In general, Caterpillar isn’t thought of as a "growth" stock, particularly since the were pretty much treading water from 1998 to 2002. For the last couple of years, however, business has been good, with demand for Caterpillar products rising both domestically and globally. The report today implies that the strong market conditions that have driven Caterpillar in the last couple of years are not only not leveling off, they are getting stronger.

Caterpillar placed the drivers for their higher guidance on the strong market conditions of the industries that need Caterpillar’s core product lines of heavy construction equipment and earth-movers. Caterpillar reported strong demand coming from the following industries: a) mining, where rising precious metal prices are driving new investment; b) increased capital investment by utility companies, driven by higher profits ; c) still strong residential housing demand, in both the US and other countries; d) increased profits at trucking and shipping companies being reinvested in upgraded cargo moving equipment; e) government driven infrastructure projects.

The irony at the macro level, however, is what is really interesting about Caterpillar’s report today. Everything that is driving Caterpillar’s healthy fundamentals is also related to everything that is worrying the rest of the stock market.

Higher oil and gas prices, viewed as an eventual damper on overall GDP growth, is driving energy company construction projects. Rising inflation fears are dampening the willingness of investors to pay a multiple for a stock, but rising inflation is also driving precious metal prices higher. That in turn is driving new mining exploration projects, using brand new Caterpillar bulldozers. The ever-increasing trade deficit is often mentioned as a deep-seated worry, but all those imports have to be shipped here and the cargo containers are off-loaded using a Caterpillar-engine-driven crane. The rising budget deficit is another black cloud looming over the economy and depressing the stock market, but some of that borrowed government money is being used to rebuild highways across the company, with Caterpillar equipment. Projects like "The Big Dig" in Boston are turning Caterpillar into "The Big Cat."

The optimistic conclusion to draw from this scenario is that there is always a way to make money in the market. It simply requires looking in the right place and with the right perspective. Caterpillar is just one example that illustrates this principle. There are many more. If the overall market conditions are making you feel pretty depressed and you are pessimistic about the future, its time to start looking from a different viewpoint. From the right angle, you can make hay whether it is sunny or cloudy. You just gotta separate the wheat from the chaff and find the right combine to reap the harvest – today the "right one" says Caterpillar on the side in bold black letters over yellow paint. – Robert V. Green

Honeywell International Inc. (HON) 36.27 -0.23: This was a strong start to the year for the industrial company, Honeywell. The Dow component reported organic growth of 6% and expanded profitability in three of four of its businesses. The result topped estimates by two cents earning $359 mln, or $0.42 per share up 24% year/year. Growth was broad-based with the top line expanding by 4.5% year/year to $6.45 bln, vs. the $6.39 bln consensus.

Its business is heavily weighed to the Aerospace and Automation & Control segments accounting for 70% of total sales, as the world’s largest maker of airplane cockpit electronics. On the Aerospace side, sales jumped 9% to $2.5 bln driven by increased parts orders from Boeing and Airbus as global flying hours and the global freight business continued to rise. The Commercial unit gained 12%, while defense and space sales rose 5%. Segment margins swelled 180 basis points to 15.1% on strong volume growth and higher enforcement, both offsetting increased IT spending. During the quarter, HON won a 10-year maintenance agreement worth up to $125 mln from Singapore Airlines. Along with a maintenance and engineering service contract for the F-15 test systems worth more than $450 mln.

Revenue in the Automation & Control unit edged up 2% to $2.0 bln due to a 4% rise in its Life Safety & Security unit. HON completed its acquisition of Novar, the British industrial holding company, on March 31th for which it paid $1.53 bln. It also just announced (4/18) the acquisition of Zellweger Analytics, which manufactures toxic and flammable gas detection systems, expected to close in the second quarter.

Transportation increased 8% to $1.2 bln with its Turbo unit up 14% due to higher diesel penetration in Europe. Its turbochargers used to increase mileage and reduce pollution on gasoline-fuel cars have enjoyed strong growth making up almost half of the new diesel cars sold in Europe. Higher raw material costs offset increased unit volumes keeping margins flat. Co noted it has been “quite successful” in restraining commodity inflation through proactive pricing and productivity gains. The Specialty Materials unit posted a strong quarter. Excluding its divested Performance Fibers business, organic growth rose 5% driven by 11% growth in Chemicals. Price increases and productivity gains were able to counterbalance raw material costs, resulting in segment margins expansion of 180 basis points to 7.4%.

Overall segment profit margins expanded 100 basis points from last year to 11.6%. HON cited strong volume conversion, pricing gains and productivity. The market is hoping operating margins will return to prior peak levels reached in the late 1990’s of 20%+. Honeywell commented on its conference call that an asbestos bill was jointly introduced to the Senate committee last night by Senators Spector and Leahy, which it believes will be a huge step forward in resolving a 20-year national crisis. Litigation costs for asbestos liability lawsuits have weighed on the company for some time.

Looking ahead, HON anticipates sales growth in Q2 of 8-9% to $6.9-7.0 bln, vs. consensus of $6.7 bln. It sees EPS of $0.49-0.51 – roughly in-line with consensus of $0.50 with minimal impact from Novar in the Q2. For FY05, it expects revenues to range between $27.3-27.6 bln above consensus of $26.9 bln as it includes the benefit of the contribution of Novar IBS. It forecasts EPS in the range of $1.95-2.05, which is consistent with its prior guidance, but does expect to come in at the high end, vs consensus of $2.02.

After restructuring its business, which included workforce reductions and streamlining operations, Honeywell is reaping the benefits. The cyclical recovery in the commercial aerospace and industrial industries has provided support and will continue to do so throughout the year. The outlook for the company, as well as shares, looks quite good driven by its strong financial position, revenue acceleration, and earnings momentum. New products, along with accretive acquisitions, and new orders from Airbus will provide further upside going forward. The stock is trading at 18.1x forward earnings near the high end of its historical average. However, the earnings portion of the multiple is likely to expand as the year unfolds. —Kimberly DuBord, Briefing.com

Page One – Mixed News: Good Earnings, Bad CPI : Stock futures signal a mixed open. The earnings news is undeniably good, the CPI data bad.

Intel gets top billing, and with this company we agree with the emphasis on a technology company. Intel is the focal point of the entire sector. The company reported a 21% increase in per share profits to $0.34 for the first quarter which was 3 cents ahead of expectations, and they also exceeded revenue expectations. Also very important was a sharp increase in their capital spending plans for 2005. They raised their forecasted range to $5.4 to $5.8 billion from a previous $4.9 to $5.3 billion. That will boost the semiconductor equipment sector.

There were many more good earnings reports. Altria beat the average analyst forecast from Reuters Estimates by a penny, General Dynamics beat by 13 cents, Honeywell beat by 2 cents, JP Morgan Chase beat by 11 cents, and United Technologies beat by 3 cents. There were very few warnings associated with second quarter earnings.

Overall, the earnings reports in aggregate continue to be outstanding. The vast majority of major companies are beating first quarter estimates (many by a large margin) and guidance on the outlook has been reasonably good. There is still a long way to go, but the early returns are encouraging.

March CPI brings offsetting bad news. The core rate was up 0.4%. This follows the more encouraging 0.1% March core PPI reported yesterday. An increase of this nature is clearly troublesome, and if it reflects the underlying trend, requires the Fed to remain vigilant against inflation. That means higher interest rates and slower economic growth. Ultimately, slower economic growth will reduce the current demand-pull inflation, but that is of little encouragement to the stock market today.

This puts the Federal Reserve Beige Book report on national economic conditions to be released this afternoon as even more significant. It could have a major impact on the stock market if it suggests increased inflationary pressures or significant signs of slower economic growth. The report is anecdotal in nature and covers impressions through early April.

The earnings news so far is good. It now appears as if operating earnings for the S&P 500 in aggregate for the first quarter will rise 11% or even more. Just a few weeks ago those forecasts were at 7% or 8%. The market remains concerned, however, about evidence of slower growth in the economy which has not yet had the time to reduce inflationary pressures.–Dick Green, Briefing.com