Fitch affirms A ratings for Caterpillar's IDR, long-term debt; outlook stable

Andrew Rogers

CHICAGO , April 3, 2012 (press release) – Fitch Ratings has affirmed the Issuer Default Ratings (IDRs) and Long-term debt ratings at 'A' for Caterpillar Inc. (CAT), Caterpillar Financial Services Corporation (CFSC), and CFSC's subsidiaries including Caterpillar Financial Services Australia LTD. Fitch has also affirmed the companies' Short-term ratings at 'F1'. The Rating Outlook is Stable. A full ratings list appears at the end of this release.

The ratings for CAT, with CFSC on an equity basis, are supported by strong financial performance at CAT's Machinery and Power Systems (M&PS) businesses. A cyclical recovery in demand for machines and power systems, combined with improving margins, is contributing to higher sales and earnings. Debt to EBITDA at the end of 2011 was 1.1 times (x), only slightly higher than one year earlier despite a material increase in debt used to fund the $8.8 billion acquisition of Bucyrus in July 2011. As a result, Fitch's previous concern about temporarily higher leverage following the Bucyrus acquisition has diminished. Other risks remain, however, including execution risks related to the concurrent integration of multiple acquisitions, and CAT's exposure to economic downturns while it absorbs acquisitions and expands capacity at existing businesses.

Rating strengths include CAT's global presence, established and well capitalized dealer network, strong competitive position, diverse customer base, operating discipline, solid free cash flow, and strategic benefits from the acquisition of Bucyrus. Following the Bucyrus acquisition, CAT has the broadest product line in mining capital goods. In addition, the acquisition added substantial aftermarket revenue, and CAT's global distribution network should further improve customer service and product support for the legacy Bucyrus business. Also, CAT expects to realize revenue and synergy benefits, including putting CAT engines in more of Bucyrus' machines.

Additional acquisitions could be completed in 2012, but large transactions beyond those already announced are unlikely while CAT focuses on integrating completed acquisitions. CAT acquired MWM Holding GmbH (MWM) for $774 million in the fourth quarter of 2011 and is in the process of offering as much as $900 million for ERA Mining Machinery Limited (ERA), a maker of underground mining equipment in China. CAT also has agreed to acquire in the second quarter of 2012 the remaining 33% of Cat Japan Ltd. not already owned by CAT, which had a value of $473 million at the end of 2011.

The integration of CAT's acquisitions is occurring at the same time that CAT is ramping up production and expanding capacity to meet rising customer demand. Demand for mining equipment should continue to benefit from rising raw material costs associated with growth in emerging markets. The economic recovery in most regions outside Europe is contributing to increasing demand for energy, and delayed investment in machines during the previous recession has resulted in aging equipment and low inventories in rental fleets. These trends more than offset a weak market for marine engines and depressed construction markets in developed regions. Even a slow improvement in construction activity, however, would increase demand for CAT's machinery. CAT's backlog was a record $30 billion at the end of 2011.

CAT's production capacity is constrained, and it plans to increase capital expenditures by 50% in 2012, to $4 billion, compared to $2.6 billion in 2011. Fitch believes spending could stay at elevated levels at least into 2013. Spending is directed globally toward existing and new facilities. Sixty percent of capital expenditures were located in the U.S. in 2011, but CAT is also expanding in most other regions around the world.

Free cash flow (FCF) (excluding CFSC) increased in 2011 to $2.8 billion compared with $2.1 billion in 2010. Fitch excludes from free cash flow changes in accounts receivable purchased by CFSC which Fitch classifies as cash flow from financing. In 2012, Fitch estimates FCF will decline to $1.3 billion - 1.4 billion due to larger pension contributions and the planned increase of approximately $1.4 billion in capital expenditures. The impact on cash flow and liquidity could be partly offset by asset sales. CAT is in the process of selling Bucyrus' distribution business to various CAT dealers. Some of the larger transactions could occur in 2012, but the process may not be completed until after 2012. CAT is also considering the divestiture of its third party logistics business which is profitable but is not considered a strategic asset.

CAT's global pension plans were 67% funded at the end of 2011 compared with 81% at the end of 2010 and 76% at the end of 2009. Funding worsened in 2011 due largely to a decline in the discount rate. CAT contributed $446 million to its plans in 2011 and expects to contribute approximately $1 billion in 2012, including required contributions. At the end of 2011, net pension obligations totaled nearly $6.3 billion.

Other credit concerns include CAT's cyclical end markets, weak conditions in parts of Europe and in U.S. construction markets, slowing growth in emerging regions, and the development of Tier 4 emissions technology required to comply with emissions standards for off-road vehicles. CAT's Tier 4 technology is being implemented through 2014, and its success will be important to the company's competitive position and profitability. Another concern is raw material input prices, although CAT gets some benefits as higher raw material prices drive increased activity in its mining end markets.

The ratings or outlook could be revised upward if long-term demand is sustained in CAT's end markets, acquisitions are integrated successfully, the company expands market share in emerging regions, financial leverage is maintained consistently at low levels through business cycles, and CAT implements new technology effectively to meet emissions regulation or changing market demands. The ratings or outlook could be negatively affected if operating results weaken materially due to poor execution or an economic downturn; market share is impaired in key product lines or geographic regions, or aggressive cash deployment results in higher leverage.

CAT's financial results can be expected to improve further in 2012. The pace of sales growth, excluding the impact of acquisitions, is moderating as year-over-year comparisons become more difficult, but sales growth should benefit from growing demand in most of CAT's markets. EBITDA margins improved by approximately 160 bps in 2011 and could improve again in 2012, reflecting the positive impact of higher volumes and favorable pricing which more than offset increases in costs related to product development and investments in new capacity. One-time acquisition costs should decline although some integration expenses will continue into 2012. CAT's ability to control costs is supported by its lane strategy designed to reduce delivery times, and the CAT Production System which focuses on operating efficiency.

CAT's liquidity (excluding CFSC) at Dec. 31, 2011 totaled $3.1 billion, including cash of $1.8 billion and credit facility availability of $2.0 billion, offset by $715 million of short term debt and long term debt maturities. The $2.0 billion of credit facility availability is the internal allocation to M&PS of CAT's consolidated $8.5 billion facilities. The facilities primarily support commercial paper programs. CAT can revise the allocation of these facilities between CFSC and its manufacturing businesses at any time. The facilities consist of a $2.55 billion 364-day facility that expires in September 2012, a $2.09 billion facility that expires in September 2014, and a $3.86 billion facility that expires in September 2016. CAT has $388 million of other committed and uncommitted lines, not including facilities available to CFSC.

Under inter-company agreements, CAT may borrow up to $1.67 billion from CFSC and CFSC may borrow up to $2.12 billion from CAT, on a short-term basis. In addition, CFSC provides a $2 billion committed credit facility to CAT which expires in 2019. CFSC also purchases, at discount, dealer and customer receivables from CAT. Receivables balances purchased by CFSC totaled nearly $3.2 billion at Dec. 31, 2011 compared to $1.8 billion at the end of 2010 and $1.1 billion at the end of 2009. During 2011, CFSC repaid to CAT a $600 million inter-company loan and paid a $600 million dividend.

At CFSC, operating performance has benefited from improved financing volume and a reduction in credit costs. Retail originations increased 20% in 2011 and net income was up nearly 36%. While originations are still below historical levels, near- to medium-term demand for CAT products will benefit from pent up demand for infrastructure replacement in the U.S. as well as growth in international markets such as China. Profitability increased due to higher net yields on earning assets, improving values for returned or repossessed equipment and stronger asset quality, which contributed to lower loss provisions.

Asset quality performance is improving and trending toward historical averages, with delinquencies (30+ days) declining to 2.89% of receivables at Dec. 31, 2011 compared to 3.87% a year ago. This compares favorably to peak delinquencies of 5.54% in 2009 and a five year average of 3.71%. Fitch believes some additional improvement in asset quality is possible, but expects relative stability in the near term. The asset quality of wholesale financing provided to CAT's dealers is quite high, and delinquencies and losses typically are concentrated in the retail portfolio.

CFSC's capitalization is consistent with similarly rated peers. CFSC's debt to tangible equity ratio was 7.42x at Dec. 31, 2011, up from 6.35x in 2010 following an 8% increase in the loan book. Despite the increase, CFSC's leverage falls within the historical range of 7.0x - 8.0x. While Fitch does not anticipate any significant changes in CFSC's overall capital structure, should the company's funding requirements increase unexpectedly, Fitch believes CAT will inject additional capital as necessary to maintain CFSC's leverage target.

CFSC relies on a number of global debt capital markets and funding programs to provide liquidity for its operations, as well as support from CAT in the form of funding agreements. The company's ability to access the global capital markets demonstrates the strength of CAT's brand and franchise. Fitch believes CFSC's comprehensive funding platform, in combination with the financial strength of its parent, is consistent with its existing ratings.

CFSC's debt ratings are dependent on the support of CAT. The financial relationship between CFSC and CAT is governed and defined by a Support Agreement which requires CAT to maintain 100% ownership of CFSC, maintain CFSC's net worth at not less than $20 million, and maintain CFSC's fixed-charge coverage at not less than 1.15x or higher on an annual basis.

The ratings cover approximately $9.2 billion of debt at CAT and approximately $25.4 billion of unsecured debt at CFSC as of Dec. 31, 2011.

Fitch has affirmed the ratings as follows:

Caterpillar Inc. (CAT)

--IDR at 'A';

--Senior unsecured notes at 'A';

--Short-term IDR at 'F1';

--Commercial paper (CP) at 'F1'.

Caterpillar Financial Services Corporation (CFSC)

--IDR at 'A';

--Senior unsecured notes at 'A';

--Short-term IDR at 'F1';

--CP at 'F1'.

Caterpillar Financial Services Australia

--Short-term IDR at 'F1';

--CP at 'F1'.

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