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Caterpillar’s 2010 World Economic Outlook

[CAT, the world’s leading seller of heavy equipment for the construction, mining, and agricultural industries, is in as good a position as anybody, anywhere, to make these kinds of forecasts. CAT also has a captive finance business whose health is an indicator of the state of worldwide credit markets. The info posted below is part of CAT’s 4Q09 financial report, which was issued on 1/27/10.]

http://finance.yahoo.com/news/Caterpillar-Expects-Higher-prnews-1986735161.html?x=0&.v=1

›Recent economic data indicates that the world economy started growing again, ending the world's worst postwar recession. We expect this recovery to last throughout 2010, with the world economy growing more than 3 percent.

• We expect interest rates will remain low since unemployment rates are high and inflation rates are low. Even though we do not expect inflation will become a problem, we expect some central banks will eventually implement precautionary interest rate increases.

• We project the Federal Reserve will increase rates from about 0.15 to 1 percent by the end of 2010; the European Central Bank, from 1 to 2 percent. Australia has already increased rates to 3.75 percent and likely will increase rates a further 100 basis points in 2010. Several developing countries, including Brazil, China and India, likely will increase rates.

• Most key credit spreads have returned to normal and large businesses have access to credit. We expect credit standards for consumers and small businesses will ease, improving credit availability.

• Stimulus programs should have maximum impacts in the first half of 2010. Some governments may expand programs to provide additional support.

• Commodity prices improved steadily throughout 2009, and most prices are well above levels needed to encourage increased production and investment. In addition, we expect that world demand for most commodities will increase this year, further tightening supplies. Our planning assumes oil prices will average $83 per barrel, and copper prices will average $3.20 per pound.

• Developing economies are growing again, and we expect they will lead the economic recovery. Economic growth in the developing world should be about 6 percent in 2010, up from 1.5-percent growth in 2009.

• Asia/Pacific was the first region to recover, and growth should reach almost 7.5 percent in 2010. We expect more than 10-percent growth in China and 8-percent growth in India. These high growth rates should continue to improve construction spending and encourage investment in mining capacity.

• Latin American economies recovered rapidly in the last half of 2009, and we forecast regional growth of almost 4 percent in 2010. Ongoing recoveries in construction and mining should continue.

• The economies of Africa/Middle East and CIS should grow about 3.5 percent in 2010. Higher energy and metals prices should encourage producers to increase investments and production.

• Developed economies have performed poorly for several years, and recoveries have been slower to develop. We expect these economies will grow 2 percent in 2010, which will maintain significant excess capacity and keep inflation subdued.

• We forecast 3.5-percent growth in the U.S. economy, which is slower than past recoveries from severe recessions. Housing and mining production should improve from very depressed levels in 2009. However, we expect continued decline in nonresidential building construction, and delays in passing a highway bill likely will cause highway contractors to remain cautious about purchasing equipment.

• The European Central Bank appears to be reducing its liquidity support, and bank lending remains weak. We expect very modest recovery in 2010—economic growth of about 1 percent. Construction surveys indicate spending should rebound somewhat, particularly for infrastructure.

• The Bank of Japan has not been able to end deflation and the associated weak economic growth. We do not expect any policy improvements this year, and the Japanese economy should grow only 1.5 percent in 2010.

• For 2010, one of our most significant economic concerns is that central banks in the developed economies will misjudge inflation risks and begin raising interest rates too quickly. Doing so could lead to a renewed downturn that would be worse than the one just ended. However, we do not expect that rate increases will occur early enough, or be large enough, to be a major problem in 2010.

QUESTIONS AND ANSWERS

[I omitted questions that pertain only to CAT’s specific operations.]

Q1: Can you comment on China's economic recovery and expectations for 2010?

A: Economic growth in China was impacted by the worldwide recession, slowing from 9 percent in the third quarter of 2008 to 6.2 percent in the first quarter of 2009. Industrial production declined slightly in late 2008, and exports declined 34 percent between May 2008 and February 2009. Our dealer sales of machines to end users declined from September 2008 through January 2009. The Chinese government increased infrastructure spending sharply, and the People's Bank of China eased credit conditions. These actions improved the economy and construction activity. As a result, dealer machine deliveries have also increased. The economy grew 10.7 percent in the fourth quarter of 2009, and dealer deliveries to end users ended the year at a record rate.

The People's Bank of China recently increased reserve requirements to slow bank lending. However, we believe these actions will not have much impact until later in 2010, and we expect the economy will grow more than 10 percent this year. Our sales in China should increase significantly in 2010.

Q2: What does your 2010 outlook assume for U.S. housing starts?

A: We project housing starts of about 1 million units in 2010, up from 554,000 units in 2009. This increase, although large, would make 2010 the third-lowest year for housing starts since 1945 [!]. Only 2009 and 2008 would be lower. Historically, housing starts have been volatile; for example, housing starts rebounded from 1.1 million in 1982 to 1.7 million in 1983, a bigger unit increase than we project in 2010. Builders have completed fewer new single- family homes than they have sold since August 2006, and the inventory of unsold new homes is the lowest since April 1971.

Single-family homes under construction, as well as the total for all housing units, are at a record low. The severe recession caused household formations to slow sharply the past two years to about half the normal rate. Housing affordability is almost the best on record, and a strengthening economy should encourage a recovery in household formations. This increase in demand, plus the drastic curtailment in supply, underlie our forecast of increased starts.

Q3: Please provide an update on your mining business. Have sales and orders picked up, and how is mining shaping up for 2010?

A: The pace of order intake increased significantly in the fourth quarter of 2009. We expect increased activity in our mining business in 2010, primarily due to strong base metal prices that we expect to remain well above investment thresholds. Worldwide mining customers are cautiously optimistic, and quoting and investment activity is increasing.

Q5: Did dealers reduce inventory in the fourth quarter as you expected? Do you expect that dealers will continue to reduce inventories in 2010?

A: Dealers reduced new machine inventories by about $800 million during the fourth quarter, for a total reduction of about $3.3 billion for the full-year 2009. In addition, dealers reduced inventories of new engines by about $600 million from year-end 2008. We do not expect these significant reductions to continue. For 2010 we expect that dealer inventories will end the year at levels similar to 2009.

Q6: We think of your turbines business as "late cycle" and understand that 2009 was a very good year. However, 2010 may be more difficult. Can you comment on expectations for 2010?

A: Based on order activity, sales are forecast to be down from peak highs in 2008 and 2009, but still at healthy levels from a historical perspective. In addition to new equipment, turbine sales include related services, which continue to grow with expanded offerings to our customers and ongoing support of our large field population.

Q7: You listed unfavorable product mix as a major factor relative to your profit outlook for 2010. Can you provide more information?

A: We sell more than 300 different machine models, a wide range of engines and an extensive array of services. As the mix of sales of products and services varies, it can have a substantial impact on profitability. In 2010 we are expecting an unfavorable impact from the changing mix of sales.

Q8: Given the extent of inventory declines in 2009 and your outlook for higher sales and production in 2010, many of your suppliers will see significantly higher demand from Caterpillar in 2010. With 2009 volume so low and the financial concerns so difficult, are they prepared for 2010?

A: In 2009 our suppliers did an exceptional job of ramping down production. Through what was the sharpest decline in decades, we didn't have significant supplier-related disruption to our business. Suppliers, particularly those that support our machine component and assembly facilities, will likely see significant volume increases in 2010. In the fourth quarter of 2009 we began meeting with key suppliers to discuss expectations for 2010 and their ability to ramp up production. Overall, we're confident in our supply base and its ability to support the growth we expect in 2010.

Q12: Have you increased employment levels as a result of improving business conditions? Do you plan to increase employment in 2010?

A: Employment needs are linked to business conditions and production volume. The fourth quarter of 2009 continued to be very weak from a production standpoint, and overall employment declined slightly from the end of the third quarter. However, we are seeing signs of improving demand, and dealer orders have increased. We have raised production schedules in some facilities, and we would expect to selectively increase employment in 2010 as a result. The strength of recovery will vary significantly among product type, industry served and geography. Currently we are seeing faster recovery in Asia and Latin America. So, prospects for employment increases in 2010 are best for facilities in those regions and factories that are significant exporters to those regions.

Q16: Give us an update on the quality of Cat Financial's asset portfolio. How are past dues, credit losses and allowances?

A: During the fourth quarter, overall portfolio quality continued to reflect signs of stress related to general economic conditions. At year-end 2009, past dues were slightly lower at 5.54 percent compared with 5.79 percent at the end of the third quarter. At year-end 2008, past dues were 3.88 percent. We expect there will be continued pressure on past dues during the first half of 2010, with gradual improvement as the global economy improves in the second half of the year. Bad debt write-offs, net of recoveries, were $86 million for the fourth quarter of 2009, up from $65 million in the third quarter of 2009 and $60 million in the fourth quarter of 2008. Total bad debt write-offs were $253 million in 2009 compared to $121 million in 2008. The $132 million year-over-year increase was driven by adverse economic conditions, primarily in North America, and to a lesser extent in Europe. Full-year 2009 losses were 1.03 percent of the average retail portfolio compared to 0.48 percent for 2008. This result was higher in comparison to the peak of 0.69 percent reached in the most recent periods of economic weakness in 2001 and 2002. At the end of 2009, Cat Financial's allowance for credit losses was 1.64 percent of net finance receivables, increasing from 1.44 percent on December 31, 2008. The allowance for credit losses totaled $377 million compared with $395 million on December 31, 2008. The decrease in allowance for credit losses reflected a $64 million reduction due to a reduction in the overall net finance receivable portfolio, partially offset by a $46 million increase associated with the higher allowance rate.

Q17: Do you expect Cat Financial's past dues to improve in 2010?

A: Although considerable uncertainty still exists for 2010, we expect past dues to remain at elevated levels during the first half of 2010 and gradually improve in the second half of 2010 as the global economic recovery continues.

Q18: Can you comment on Cat Financial's liquidity position in general? Will you need new long-term debt in 2010?

A: Cat Financial has been able to access ample liquidity to cover all maturing debt obligations utilizing a broad and diverse global funding program. For the full-year 2009, Cat Financial issued $3.4 billion in U.S. medium-term notes, $690 million in U.S. retail notes, euro 650 million in euro medium-term notes, C$500 million in Canadian dollar medium-term notes, yen 14.4 billion in Japanese yen medium-term notes, A$250 million in Australian dollar medium-term notes and ARS 61.8 million in Argentine peso medium-term notes. Year-end 2009 commercial paper outstanding totaled $2.2 billion. Commercial paper is supported by a revolving credit facility shared jointly with Caterpillar Inc. that provides $5.5 billion in liquidity allocation to Cat Financial. This committed facility remains undrawn and available and provides Cat Financial with the capacity to issue additional commercial paper as needed. Proceeds from Cat Financial's 2009 debt issuance, combined with year-to-date cash receipts, covered all 2009 debt maturities and generated a cash balance of $2.5 billion at the end of the fourth quarter of 2009. Our resulting liquidity position remains strong. Cat Financial 2010 term debt maturities are approximately $4.9 billion, of which a portion will be funded by current cash balances and projected cash receipts. Cat Financial will remain selective and opportunistic in issuing new term debt in 2010.‹