TEXT-Fitch comments on Caterpillar Inc

Sept 27 - Fitch Ratings believes a softening outlook for heavy equipment sales to the global mining and construction industries could eventually lead to moderately weaker credit metrics for Caterpillar Inc. (CAT) and could potentially have the same effect on other companies with similar exposure to these industrial customers. Weakening demand for construction and mining-related equipment underscores continuing signs of slowing global economic growth. Rising mining costs in Australia as well as softening demand have resulted in rationalization and project delays that will impact mining equipment volume. In the U.S., coal mining is suffering from near-term competition from extremely low natural gas prices and producers are redeploying equipment and cutting capital spending. Mining represents the majority of CAT's Resource Industries segment, which generates approximately 30% of Machinery and Power Systems (M&PS) revenue. We believe muted demand in the mining industry could temper near-term benefits from Caterpillar's integration of Bucyrus which was acquired last year. CAT is also integrating other previous acquisitions, including MWM Holding GmbH and ERA Mining Machinery Limited. While risks to CAT's financial performance have increased, the Rating Outlook continues to be Stable, reflecting CAT's strong operating profile, large market share, effective product development, and financial flexibility. CAT has reduced leverage since the Bucyrus acquisition was completed in mid 2011 (debt/EBITDA was 1.1x at June 30, 2012 at M&PS), but benefits of the transaction, including cost improvements and using CAT engines and other components in Bucyrus' equipment, may occur more slowly if demand declines further for coal, metals, and other commodities. Mining companies have postponed large projects and reduced capital spending plans that drive sales of mining trucks and other equipment produced by CAT. Other concerns that surround demand for CAT's equipment include slower economic growth in China that has reduced excavator sales by as much as 30%-40%, the increasing use of natural gas that is replacing coal consumption in the U.S., and construction activity that remains at low levels in developed regions. Fitch estimates free cash flow (FCF) at M&PS could decline by approximately half for all of 2012 from $2.8 billion in 2011, reflecting larger planned pension contributions (including voluntary contributions) and an increase in capital expenditures expected in 2012. (Fitch excludes from FCF changes in accounts receivable purchased by Caterpillar Financial Services Corporation.) However, cash flow could benefit from steps taken by CAT to adjust or delay the pace of capital expenditures. Also, an improvement in inventory turnover could generate additional cash in a weak operating environment. Our primary credit concerns for CAT revolve around volume in the mining business and the effectiveness of its realignments and cost reductions following completed acquisitions. We note that CAT has made significant operating improvements during the past few years that should enable it to cope effectively with a moderate slowdown. Also, the substantial amount of aftermarket business acquired with Bucyrus mitigates CAT's exposure to equipment sales. However, margins and cash flow could be sensitive to a sustained or significant economic downturn and economic trends in CAT's mining and construction markets will be especially important in the near term. CAT is not alone in noting heightened risks associated with a global slowdown. Transportation bellwethers Maersk, FedEx, and Norfolk Southern have all cautioned in recent weeks that slowing growth in China, in addition to ongoing uncertainty in Europe and risks related to the U.S. fiscal cliff, will affect future earnings. We forecast China's 2012 growth at 7.8%, trimmed down in June from our 8.0% expectation, reflecting the release of data showing real GDP grew 7.6% year-over-year in Q212. We expect some modest quasifiscal stimulus to raise growth towards 8.0% by year end and to support growth of about 8.2% in 2013, followed by 7.5% in 2014. Taking into consideration recent monetary policy interventions by the Federal Reserve, European Ccentral Bank, and Bank of Japan, we project that economic growth in the major advanced economies will remain sluggish at 1.0% in 2012, followed by only a modest acceleration to 1.4% in 2013 and 2.0% in 2014. Our global growth forecast is 2.1% for 2012, 2.6% in 2013, and 3.0% in 2014. For a complete listing of CAT and CFSC ratings, please see our website www.fitchratings.com. Fitch's latest Global Economic Outlook, released today, is also available there.