Category: Articles

Not good short term…

From the FT:

Speaker key:

HW: Hal Weitzman

JO: Jim Owens

Part 1: On the US economy

HW: Mr Owens, thank you for joining us.

JO: My pleasure, Hal.

HW: Let’s start by talking about the US economy. Two years ago Caterpillar became one of the first big American companies to warn that the US was entering a serious economic downturn. Now, this year you’ve been more optimistic, but in the first three months of the year you actually recorded your first quarterly loss for 17 years, and last week you warned that you might make a loss in this current quarter. So are we seeing green shoots or are they withering?

JO: Well, let me be careful here. I’m not that caught up on the quarterly numbers at all. I think we warned about a slowing of the economy because the US economy peaked in 2006 and, as you recall, housing starts were about 2.2 million starts back then. It came off pretty sharply. We could see this bubble building and we felt the economy was going to come off so by late 2007- 2008. The housing market, for example, in the US was cascading down, which had a big impact on a lot of our product lines in the United States. We recorded all time record sales results, revenue and sales results in 2008, but we did that despite the fact that the US, Japan and Western Europe were in outright recession for the latter half of the year and, of course, the US was in it even earlier than that. And particular sectors that we serve, like housing, were down and very severely depressed. In fact, 2008 was the worst year we’ve had since World War II. So we were well into it. And the first quarter of this year, we came into this year – keep in mind the post Lehman Brother’s collapse, so the September 15th to November 15th period of time – the global economy literally flipped upside down and got a lot worse, particularly the global credit markets.

So we went from, well, let’s call it normal cyclical recessionary conditions in the US, Europe and Japan and good growth in the emerging markets, to a world that was upside down, in 90 days. And most people forget, how quickly we forget, a couple of factors. One, is that the best three years of growth since World War II were the 04 to 06 period. In that period we were scrambling and booming to add capacity worldwide. In this post Lehman period, the 90 day period, essentially every stock market in the world dropped between 35% and about 80%. Every major commodity from oil and gas to iron ore to copper, the big market segments we serve, dropped between about 35% and 60% in 90 days. And currencies, of course, moved dramatically in this period also. Credit markets became dysfunctional, literally a seizure in those. So only the very best companies were able to borrow at all. And we went from three year order backlogs for many of our product lines to mass order cancellations, which we allowed recognising the economic game had changed; and changed overnight almost.

In the first quarter, I guess, we lost money for the first time but we made money on an operating basis, the redundancies that we took. We did some right things for our people in that we offered early retirement programmes that cost us more than just firing people. We offered to maintain health insurance, for example, for our American employees where that’s a big issue, for one year into a layoff – it went that long. And we offered to do some supplemental compensation. We wanted our managers to rightsize the organisation to compete with radically lower volumes, and do it quickly. So all those costs we took in the first quarter.

In the second quarter the markets were pleasantly surprised because it was really a post management story. We were able to take out cost associated with about 34,000 people that showed up for work every day within a four month period. So we had, kind of, strategically positioned ourselves to be flexible, we exercised that flexibility and we see a significantly lower, going forward cost run rate by the second quarter, in place. So I think we demonstrated the elephant here could dance pretty well when forced to. A lot of unpleasant things we certainly … it’s a lot more fun to grow and to hire people, but quite frankly, to be successful in the capital intensive goods business you need the flexibility that we’ve tried to build into our systems.

HW: But are you optimistic now? Do you think we’ve now reached the bottom in terms of demand for the heavy equipment that Caterpillar makes?

JO: The green shoots, and I think they are still green shoots at this time, there’s a couple of things. First of, global credit markets and particularly for companies that are good credit risk, such as ourselves, the credit markets have stabilised, largely normalised, we are able to go to market for medium terms notes in Europe and Canada. The US market is functioning well, commercial paper markets are functioning well. Our CapFinance company is now solidly profitable again, we can look at growing that portfolio. We’re confident about its ability to do good underwriting and manage lending to our customers, which will help them. Four or five months ago that business model was completely upside down because the banks that were guaranteed at very low interest rates and everyone else, regardless of quality, paid a huge premium. Those spreads have now narrowed, and in fact, in the last few months we’ve been able to borrow at rates lower than we were borrowing a year ago. So we’re encouraged on that front.

Secondly, our sales to users, retail sales if you will, which were in freefall from October of last year through to the first quarter, kind of bottomed out in that April/May timeframe, and we looked at sequential months we’re seeing stabilisation and maybe even a slight improvement in that.

Part 2: On the global economy and protectionism

HW: You spoke about raising money around the world and Caterpillar is a very global company, almost two thirds of your revenues come from markets outside North America. Where do you see the best recovery happening? What geographic area of the world?

JO: We were into a discussion about the emerging markets of the world being our growth opportunity in 2008 – in fact they were carrying the day. There’s not been a complete decoupling of the world certainly, and when the OECD world, all of it, is in severe recession and credit markets sees the emerging markets are also negatively impacted. But we still think that’s a fundamental court case for the macro economy for the next decade. That the emerging markets of the world, particularly emerging Asia – it’s China, India, South East Asia, the ASEAN group, it’s parts of the Middle East, the southern part of Africa, it’s Latin America almost in total and eventually CIS and Eastern Europe, which have been the most adversely impacted by this crisis.

But we see the growth rates in that large group of countries with vast populations, growing at two to three times the OECD world growth rate in the decade ahead. And we think they’re at the economic development stage where that’s going to drive demand for a fair bit of commodities, both energy and basic minerals, just because of the stage of economic development, the emerging middle class that’s present in those countries and we think that plays to our product line strengths.

HW: You’re an outspoken advocate of open markets and free trade.

JO: Absolutely.

HW: Are you concerned about the drops in global trade that we’ve seen and possibly the rise or the return of protectionism?

JO: I’m very concerned about that. I think that the greatest risk we have today in the world economy would be a reversion to nationalism, protectionism, call it what you will, that impedes the flow of goods and services around the world. I think the world benefited hugely by cross-border investments and rapid growth in exports and imports, standards of living in countries that were open improved much faster. The big change that facilitated the very impressive growth that we registered in the 04 to 06 period was the opening of markets, be it China or Russia and Eastern Europe, and bringing them into the global family of trading nations. I think specifically about the United States where it’s really encouraged us – we’ve kind of led trade liberalisation since World War II. Some in our country would argue that we could be a great country by building a big enough wall down the southern border and I think it’s nonsense.

HW: On that note, you criticise the buy America provision that was included in the US stimulus bill. Has that been as damaging as you had feared?

JO: I think it’s been damaging on a psychological front. It’s relatively small in terms of its real impact on the imports or exports, but the fact that we as a country put a buy America provision in our stimulus bill, says we don’t have confidence in American companies’ ability to compete for and win that business in open competition. I feel our construction equipment customers should, quite frankly, have the choice between JCB and Komatsu and Volvo and Caterpillar. And I’d like to think that we can provide products and services that will allow us to win that business. In the same context, I want to be able to compete for business in Europe and Japan and China and Brazil and other countries. I think by us, the United States, putting a buy America provision in our stimulus package; we encourage other countries to do the same – tit for tat here.

HW: You are a member of President Barack Obama’s economic recovery advisory board. Do you feel that the administration has listened to industry and the concerns of industry and lent its support during this downturn?

JO: I think it’s early days. President Obama came to office when the economy was pretty much in freefall, particularly following Lehman’s collapse. So his first order of business was, A), just restoring confidence that we have a sound government, that we’re going to aggressively address the issues in the early days, stabilising the banking system, which I think they’ve done a pretty good job of addressing and getting it stabilised. And now, maybe moving back from having to do that with better, more thoughtful regulation but without direct government intervention is going to be an important step. Getting a stimulus bill passed, it wasn’t a perfect stimulus bill even by the President’s measure and certainly not by industry’s measure, but it was a stimulus bill that helped us rebuild and restore confidence that we weren’t going to go over the falls into a deep global depression. I think most people in the business community, financial community, would say that we are now confident, we’re not going to go into a depression. It may be a prolonged period of slow growth and the question now before the House is going to be to get the macro-economic policies in place that will get real economic growth in the world going back at a level which begins to employ a lot of people again.

Part 3: On the US stimulus and American manufacturing

HW: But it’s interesting that you bring up jobs because President Obama came here to Peoria, to Caterpillar’s home town last year to promote the stimulus. And he said at the time that if this is passed companies like Caterpillar will be able to hire back some of the workers that they’ve let go in recent months. Now more recently we’ve heard the criticism that this stimulus has not lived up to its billing as a job creation package. What are your views?

JO: I think first off there’s always leads and lags here. It takes time for the stimulus money to get into the economy and to create jobs and that was one of my cautions coming in – we had a little miscommunication on the timing …

HW: What was the miscommunication?

JO: Over how soon a stimulus bill would positively effect employment in the economy in general. I think, first off, unemployment is a lagging indicator, so it stays higher for a little longer and then when it starts going down there will be probably several quarters of positive GDP growth before we see employment beginning to pick up again. In the case of our own plants, yes, an effective stimulus bill which generates real growth in the United States eventually creates jobs at Caterpillar. But passing the stimulus bill doesn’t translate into jobs overnight and if there was any lack of clarity it was around… this was a sell the stimulus bill speech and the realities of how long it takes it to work through and create jobs in a Caterpillar plant …

HW: So President Obama did not consult you before he said that there might be jobs created by Caterpillar?

JO: He consulted me on the idea of the stimulus bill and we certainly agreed that the country needed, I think at that time, a substitute stimulus bill. The press has tried to drive up a big wedge here between our views on the need for a stimulus bill; I was absolutely in agreement we needed a stimulus bill. Now, the stimulus bill that we passed in the United States, I think, was a little more geared to a lot of social programmes and some necessary support for people in transition and it was a little light on hard infrastructure investment. And the amount of spin there, over a two year period, is less than at 6% or 8% of say our construction spending in the country. And you have residential construction and non-residential construction and even state and federal budgets going down, so they more than offset the amount of money in the stimulus.

HW: Was that the difference between the US stimulus and the Chinese stimulus package.

JO: The Chinese went very heavily for hard infrastructure, for roads, bridges, railroads, airports, ports – so they’re building real capacity to facilitate economic growth in the future. And one of the things, I think, we need in this country is we’ve got a lot of infrastructure that’s in a state of ill repair, so a lot of repair and fixing of roads and bridges – in some cases expanded capacity, additional air transit capacity and rail quarter capacity. These are investments that I think are meritorious, because, first off, they create a lot of jobs, there’s a big multiplier associated with this, it’s not just the construction work, but it’s the rock and quarry work that has to go behind it. The steel, the cement and other materials, the construction equipment, the maintenance of all that that drives a lot of jobs. So the multiplier is, for instance for direct construction jobs, there is a three or four multiplier on it. Whereas a lot of the programmes in the initial stimulus bill don’t have much of a multiplier.

HW: Presumably, with infrastructure spending in mind, you’ve floated the idea that the US might need a second stimulus package. Is that still your view and if so is there the political will in Washington to spend more money?

JO: I think there’s going to be a need to have, probably, an additional stimulus. I think it could be focused in, for example the Highway Bill that’s coming up in the fall, and just accelerating some of that investment because in the construction related labour markets the unemployment rates are up in the 18% and 19% range. So there’s a lot of idle capacity, if you will, to build at this point in time and a lot of job creation that could come in that space. So I think, if we make good investments, and that’s a key word here, good investments in infrastructure and accelerate some of those, it would be a very wise use of government funds.

HW: How do you think US manufacturing, generally, has fared in the downturn?

JO: I think it’s been hit pretty severely and certainly, again, the magnitude of the drop and the speed has been pretty severe and the fact that is was global in nature. So we didn’t have exports to offset the domestic decline. We’ve got a lot of resilience in many respects and clearly we have problems in the auto sector but that’s a problem of global excess capacity and a cost structure problem for the Detroit-based auto companies that they needed to address anyway.

HW: Do you think US manufactures should be concerned about low cost competition from abroad?

JO: Absolutely. I think we should be concerned about it, I think we should be gearing ourselves to compete with it. I think, in many cases, that will lead to us needing to invest in other markets around the world to establish manufacturing presence. I still think it’s important for the United States to have a very strong manufacturing base within the country and that we need to focus on areas that we can be globally competitive and that we can both manufacture for the domestic market and export, that’s a nice balance. And one, I think quite frankly, as a country, we’ve given insufficient attention to it historically. We’ve tended to think in Washington about domestic economic policy and, in fact, we have to think about or economic policy in the global context, going forward, and how American based multi national companies and American manufacturers who export from here, can compete in the world market.

HW: Mr Owens, thank you very much for joining us today.

JO: It’s been my pleasure.

LONG/SHORT

HW: Okay, Mr Owens, now we’re going to play long short. Ready?

JO: Ready.

HW: US dollar?

JO: Short.

HW: US manufacturing?

JO: Short.

HW: North American construction?

JO: Short.

HW: The Midwest economy?

JO: Short.

HW: The US Stimulus?

JO: Short.

HW: The chance of a second Stimulus?

JO: Long.

HW: Oil prices?

JO: Long. Long meaning I expect that they will go up steadily over the next decade or two.

HW: The global economy to recover by next year?

JO: Long.

HW: Protectionism?

JO: Short – I’m concerned.

HW: Barack Obama?

JO: Personally, long.

HW: Mr Owens, thank you again.

Disclosure (“none” means no position):