DBRS Confirms Caterpillar at “A” and R-1 (low)

DBRS has today confirmed the long- and short-term ratings of Caterpillar Inc. and Caterpillar Financial Services Limited (collectively, CAT or the Company) at “A” and R-1 (low), respectively. The trends are Stable. The ratings confirmation reflects CAT’s strong business profile as the leading global producer of construction and mining equipment. Although DBRS recognizes that the Company’s recent results are weak relative to historical norms and have resulted in a deterioration of CAT’s financial profile, this fact was incorporated in the ratings downgrade of May 6, 2009. DBRS also notes that the Company’s results are primarily reflective of severe conditions across key end-markets which depressed volumes sharply, rather than reflecting specific company performance. Additionally, it would appear that the worst of the downturn has likely passed as demand has started to recover, particularly in emerging markets and in the mining sector. CAT’s extensive efficiency initiatives implemented through the downturn should also serve to bolster the Company’s performance going forward as industry conditions improve.

CAT’s results in 2009 are sharply weaker vis-à-vis prior-year levels given much lower demand in both the Machinery and Engines divisions. However, DBRS notes that the Company has proven quite resilient to the downturn by maintaining profitability, albeit at modest levels. This was achieved through aggressive cost-cutting efforts that included, among other items, significant reductions in CAT’s workforce. DBRS also observes that the Company’s gross free cash flow (before working capital items) remained positive despite the challenging environment; this was primarily a function of lower capital expenditures (CAT maintained its dividend in 2009, with dividend payments slightly increasing year-over-year). Additionally, working capital was a substantial source of cash as the Company sharply lowered inventory levels; as such, net free cash flow was considerably higher year-over-year. In line with the downturn, CAT suspended share repurchases and was therefore able to significantly bolster both its cash balances and its balance sheet, with the debt-to-total capital ratio of the industrial operations being lowered to 47% as of December 31, 2009 (from a level of 59% as of March 31, 2009).

Through the first quarter of 2010, the Company’s profitability has been materially stronger year-over-year despite weaker sales levels, reflective of the significant manufacturing cost reductions achieved. Through the rest of the year, sales and profitability are expected to progressively increase, with CAT revising its outlook for 2010, citing improving market conditions and stronger aftermarket and parts orders (typically considered as a reliable leading indicator). DBRS notes that the growing demand is not evidently reflected in the Company’s first-quarter results given initial delays in ramping up production volumes subsequent to sharp declines implemented through the downturn, with CAT indicating that March was by far the strongest month in the quarter. Demand in the mining and energy sectors is significantly strengthening, with the current market prices of several commodities including copper, crude oil and coal being well above their respective thresholds for new investment. In addition, emerging market economies, particularly those in the Asia-Pacific and Latin American regions, are expected to show strong growth at considerably higher rates relative to developed economies, which nonetheless are also exhibiting muted recoveries.

DBRS expects the Company’s financial profile to continue to recover, with leverage (i.e., debt-to-capital ratio) of the industrial operations projected to decline further and approach the Company’s target range of 35% to 45%. CAT’s liquidity remained solid through the downturn and continues to be ample, with total consolidated liquidity estimated by DBRS to exceed $10.5 billion as of March 31, 2010. The ratings are expected to remain constant over the medium term. However, in the event that the Company’s improvement proves weaker than expected or CAT expeditiously resumes substantial shareholder repurchases that would have an adverse effect on its financial profile, DBRS would likely consider negative rating actions.

Note:
All figures are in Canadian dollars unless otherwise noted.

The applicable methodology is Rating the Industrial Products Industry, which can be found on our website under Methodologies.

This is a Corporate rating.