Caterpillar Inc at Vitual HQ Visit with JPMorgan Transcript

The following is excerpted from the question-and-answer section of the transcript.

Question: Tami Zakaria - JPMorgan Chase & Co, Research Division - Analyst : Of course. Before I start, let me ask you the most important question that everybody wants to know how many cups of coffee do you have to drink a day to run a company like Caterpillar?

Question: Tami Zakaria - JPMorgan Chase & Co, Research Division - Analyst : Got it. Okay. Lovely. Okay. So on a more serious note, I wanted to start off on the heels of your third quarter print, very healthy sales and strong margin performance in the quarter, and it's looking like an impressive year for Caterpillar. So talk to me about what you've seen and why the company seems to have elevated performance versus prior periods.

Question: Tami Zakaria - JPMorgan Chase & Co, Research Division - Analyst : That's wonderful. So I want to spend a little time on the services piece that you mentioned. I believe you set a target to double services sales by 2026. Who were your customers buying these parts from, if not you in the past? And what would drive this growth? Would you be adding additional dealer locations or helping dealers train technicians or a combination of those? What would really drive this growth?

Question: Tami Zakaria - JPMorgan Chase & Co, Research Division - Analyst : Got it. So let's say on digital, you mentioned that. How do you think about the focus on technology and digital innovation at Caterpillar? How does this transformation position Caterpillar for the future?

Question: Tami Zakaria - JPMorgan Chase & Co, Research Division - Analyst : Okay. That's very interesting to know. So Jim, historically, we've seen Caterpillar as more cycle-dependent with peak-to-trough sales ranging 40% or more. Given the changes you've talked about so far? And since you've become the CEO, do you expect the top line to be less volatile than it was in the past?

Question: Tami Zakaria - JPMorgan Chase & Co, Research Division - Analyst : Got it. Understood. And so going back to the free cash flow comment. Your free cash flow generation has been very strong. It looks like it's going to be above your target range this year. How do you think about your potential for cash generation going forward? LSEG STREETEVENTS | www.lseg.com | Contact Us consent of LSEG. 'LSEG' and the LSEG logo are registered trademarks of LSEG and its affiliated companies. NOVEMBER 16, 2023 / 7:00PM, JPM.N - Caterpillar Inc at Vitual HQ Visit with JPMorgan

Question: Tami Zakaria - JPMorgan Chase & Co, Research Division - Analyst : For sure. So a quick follow-up on that. Given all this very strong cash generation that we've seen, are there any gaps in your portfolio right now for which you would want to turn to M&A. And can you discuss your process for evaluating investments?

Question: Tami Zakaria - JPMorgan Chase & Co, Research Division - Analyst : Fantastic. So I wanted to switch to some near-term trends we've been seeing. So moving to our recent third quarter results. We saw some softness in order growth versus the prior quarters and some reduction in the backlog, which seems to be a big focus among investors. So could you comment on how you internally interpret a decrease in backlog? And any pattern of strength or weakness in the various buckets of your portfolio that you can talk to?

Question: Tami Zakaria - JPMorgan Chase & Co, Research Division - Analyst : Great. That's very helpful color. If you don't mind me asking about the backlog. So can you comment on the risk of cancellations in your existing order backlog. How does that has that panned out historically in terms of cancellations? And do you think this time it could be different or -- because you made process improvement? Any color on that.

Question: Tami Zakaria - JPMorgan Chase & Co, Research Division - Analyst : Got it. Perfect. And so switching gears to a different topic. I think Caterpillar has done an impressive job. The team has done an impressive job trimming the manufacturing footprint significantly while maintaining capacity. However, given sales momentum we've seen investors often ask if the current level of CapEx spend of $1.5 billion-ish is sustainable. Meaning, can the existing capacity that you have meet 10% to 20% increase in demand from all the macro tailwinds? You talked about IIJA. So should there be an increase in demand from here? Does Caterpillar have the capacity to produce more?

Question: Tami Zakaria - JPMorgan Chase & Co, Research Division - Analyst : Understood. And so going back to your profitability target, which you shared. And then I think last year, you have to tweak the margin targets down a bit, citing inflationary pressures. And so with inflation moderating again and you have exceeded the expectations. At least this year, you expect to be above the high end of that range. Would you consider revisiting those targets in light of this moderating inflation trend we are seeing?

Question: Tami Zakaria - JPMorgan Chase & Co, Research Division - Analyst : Perfect. So going back to your last earnings call, I think we've heard you say that sales to end users, even in this quarter, you expect that to remain healthy despite some slowdown in orders because of some of the factors you mentioned. Against a steep interest rate environment, what do you think is sustaining this demand from end users?

Question: Tami Zakaria - JPMorgan Chase & Co, Research Division - Analyst : Understood. And so let me switch to another hot topic right now within the industrial space, pricing. Pricing for Caterpillar has been strong double digit in the past few quarters we've seen versus low single-digit growth historically. What is a realistic scenario looking forward as, again, inflation has moderated? So what should we expect going forward? Is it going to be somewhere between the double-digit and low single-digit or come back to the historical range? Any comments? LSEG STREETEVENTS | www.lseg.com | Contact Us consent of LSEG. 'LSEG' and the LSEG logo are registered trademarks of LSEG and its affiliated companies. NOVEMBER 16, 2023 / 7:00PM, JPM.N - Caterpillar Inc at Vitual HQ Visit with JPMorgan

Question: Tami Zakaria - JPMorgan Chase & Co, Research Division - Analyst : Got it. So staying on the geographic mix. Outside of North America, it appears that price competition is strong. And with the Japanese yen weak versus the dollar, the rise of competition from Chinese manufacturers, for example, in Asia and other developing countries. How do you ensure competitive advantage of the Caterpillar portfolio of products?

Question: Tami Zakaria - JPMorgan Chase & Co, Research Division - Analyst : Got it. And so Jim, any thoughts on China, particularly? Do you think -- you've mentioned China usually is 5% to 10% of your business, but it's been softer lately. Can China become a growth area for Caterpillar as we look into 2024? LSEG STREETEVENTS | www.lseg.com | Contact Us consent of LSEG. 'LSEG' and the LSEG logo are registered trademarks of LSEG and its affiliated companies. NOVEMBER 16, 2023 / 7:00PM, JPM.N - Caterpillar Inc at Vitual HQ Visit with JPMorgan

Question: Tami Zakaria - JPMorgan Chase & Co, Research Division - Analyst : No worries. Got it. And so you've talked about -- in the past, you've talked about your operation and execution model and you've exited a few unprofitable businesses in the last several years, like you mentioned at the start of the call. Can you offer some details on what kind of benefits you've seen in the processes you use?

Question: Tami Zakaria - JPMorgan Chase & Co, Research Division - Analyst : Perfect. So Jim, I wanted to spend a little time on the financing company that you have the subsidiary. The provision for credit losses in the finco is near the lowest we've seen in many years. Could you share how do you mitigate the risk of default on that basis?

Question: Tami Zakaria - JPMorgan Chase & Co, Research Division - Analyst : That's fantastic. And on that note, interest rates have gone up a lot since the last couple of years. From your perspective, if you were to compare demand for loans now versus at the start of the pandemic or before that, how would you characterize the impact of high interest rates on demand for that specific segment of your business?

Question: Tami Zakaria - JPMorgan Chase & Co, Research Division - Analyst : Correct. Correct.

Question: Tami Zakaria - JPMorgan Chase & Co, Research Division - Analyst : Perfect. So I wanted to ask another question on your mining business. It's one of the important segments you have. What has your conversation or your conversations been like with your mining customers given they usually probably 5- to 10-year projects they look at? What has been the conversation like in light of high interest rates but as you pointed out, secular drivers of growth for the mining industry because of energy transition? So help us understand how your outlook of the mining space not just near term but over, let's say, 5 to 10 years down the road. LSEG STREETEVENTS | www.lseg.com | Contact Us consent of LSEG. 'LSEG' and the LSEG logo are registered trademarks of LSEG and its affiliated companies. NOVEMBER 16, 2023 / 7:00PM, JPM.N - Caterpillar Inc at Vitual HQ Visit with JPMorgan

Question: Tami Zakaria - JPMorgan Chase & Co, Research Division - Analyst : Perfect. I...

Question: Tami Zakaria - JPMorgan Chase & Co, Research Division - Analyst : Yes. Yes, perfect. So Jim, I think we are almost near the end of our time with you today. So one last question for you before we let you go. As the CEO of Caterpillar, what's your vision 5 years out? How do you believe Caterpillar would be different from what it is today?

Question: Tami Zakaria - JPMorgan Chase & Co, Research Division - Analyst : Fantastic. We are very excited to see where Caterpillar goes from here. Thanks, Jim. It's always a pleasure to hear you speak, and we hope to have you back again another time.

Question: Tami Zakaria - JPMorgan Chase & Co, Research Division - Analyst : Great. So next up, we have Caterpillar's Group President of Construction Industries, Tony Fassino but we will take a 5-minute break before that and come back. So stay tuned. (Break) PRESENTATION

Question: Tami Zakaria - JPMorgan Chase & Co, Research Division - Analyst : Great. So first off, can you provide us with the breakdown of the Construction Industries segment exposure in terms of road building versus heavy construction versus general construction. I think that would be helpful. LSEG STREETEVENTS | www.lseg.com | Contact Us consent of LSEG. 'LSEG' and the LSEG logo are registered trademarks of LSEG and its affiliated companies. NOVEMBER 16, 2023 / 7:00PM, JPM.N - Caterpillar Inc at Vitual HQ Visit with JPMorgan

Question: Tami Zakaria - JPMorgan Chase & Co, Research Division - Analyst : Great. And so could you share your thoughts on resi versus non-resi as you're seeing these two end markets today?

Question: Tami Zakaria - JPMorgan Chase & Co, Research Division - Analyst : That's fantastic. So we've been hearing a lot about these infrastructure stimulus-driven projects in the U.S. From your perspective, how would you assess in what inning we are in, in that journey?

Question: Tami Zakaria - JPMorgan Chase & Co, Research Division - Analyst : Fantastic. And so that's for the U.S., the stimulus packages. But outside North America, any infrastructure packages you believe could be similar multiyear tailwinds in other regions?

Question: Tami Zakaria - JPMorgan Chase & Co, Research Division - Analyst : It seems like a lot of construction activity, not just here, but all around the world. And so how does Caterpillar differentiate versus competitors for the Construction Industries segment itself? If I were to ask you what are the top two or three key differentiators, which ones would you pick and why?

Question: Tami Zakaria - JPMorgan Chase & Co, Research Division - Analyst : Absolutely. And so within the construction industry segment, what -- get -- piggybacking on the last answer you gave. The services opportunity, how do you plan to grow services revenue for this segment? Do you expect it to grow at par with the company average? Or do you think there's more opportunity in construction industry segment rather than the other two? How would you characterize that?

Question: Tami Zakaria - JPMorgan Chase & Co, Research Division - Analyst : Got it. Understood. And so I want to ask a similar question I asked Jim a bit earlier. Where are you in the digitalization effort, last couple of years with Caterpillar? Talk about how it's been building up, for example. Talk about your progress there.

Question: Tami Zakaria - JPMorgan Chase & Co, Research Division - Analyst : Great. Fantastic. So Tony, I wanted to switch to some near-term topics for a second. Some of the Construction Industry data reads we've been tracking, they've been weaker in recent months. But Caterpillar sales to end users for the Construction Industry segment have remained quite robust. What do you think is causing this disconnect?

Question: Tami Zakaria - JPMorgan Chase & Co, Research Division - Analyst : Got it. That's very helpful. So I wanted to ask you about, from a capacity perspective, where are the Construction Industries segment volumes now versus, let's say, pre-COVID? And can volumes grow over the next 5 years?

Question: Tami Zakaria - JPMorgan Chase & Co, Research Division - Analyst : That's fantastic, strong execution of lean tools, I like that. So let me ask you about your rental business. How do you expect to grow the rental business within the construction industry segments?

Question: Tami Zakaria - JPMorgan Chase & Co, Research Division - Analyst : Understood. And so Tony, switching gears, how do you see the demand for autonomy and, let's say, electrification or alternative propulsion playing out for your segment over the 5 to 10 years? Can autonomy be a software-as-a-service offering, for example, by Caterpillar in the future?

Question: Tami Zakaria - JPMorgan Chase & Co, Research Division - Analyst : Got it. That's very helpful. And so the Construction Industries segment margin is reaching 25% plus by the end of this year. It seems like that's over 5% higher than the last peak. Can you help us understand what drove this margin expansion for the segment?

Question: Tami Zakaria - JPMorgan Chase & Co, Research Division - Analyst : So we get a question from investors quite often, which is how much of this margin expansion is sustainable if construction segment volumes, for any reason, turns negative because of macro weakness or any other factors? How would you answer that question? How much of it is really sustainable and you can preserve?

Question: Tami Zakaria - JPMorgan Chase & Co, Research Division - Analyst : Great. So Tony, talk about your pricing strategy for the segment. Are you seeing competitors -- domestic or overseas competitors take advantage of better availability or currency tailwinds? And how do you react to those competitive forces?

Question: Tami Zakaria - JPMorgan Chase & Co, Research Division - Analyst : Got it. So switching gears, can you provide us with a view on how Caterpillar's Construction Industry segments would benefit from a boom in alternative energy and renewable energy sources?

Question: Tami Zakaria - JPMorgan Chase & Co, Research Division - Analyst : Got it. So let's talk about China. How do you compete in markets such as China, where there is significant price competition from local players against a weak economy right now? So do you see a pathway to growth in China for Caterpillar?

Question: Tami Zakaria - JPMorgan Chase & Co, Research Division - Analyst : Great. So let's stay on excavators. Are you halfway through rightsizing the excavator dealer inventory? Or will the fourth quarter will see the peak of this headwind? Help us understand.

Question: Tami Zakaria - JPMorgan Chase & Co, Research Division - Analyst : Okay. And the other topic you talked about in the last call was an engine changeover in the BCP category. Can you help us understand how the engine change within BCP products will help Caterpillar in the medium to long term?

Question: Tami Zakaria - JPMorgan Chase & Co, Research Division - Analyst : A quick follow-up on that. Does that engine change over help improve the margin profile from a financial perspective for Caterpillar?

Question: Tami Zakaria - JPMorgan Chase & Co, Research Division - Analyst : So Tony, I have time for one last question. As the Group President, what is your 5-year vision for the Construction Industry segment? How would it be different from the current state in terms of sales, profit margin, mix of revenues?

Question: Tami Zakaria - JPMorgan Chase & Co, Research Division - Analyst : Perfect. I think with that, I want to thank everyone, especially Jim Umpleby and Tony Fassino for joining us today. We look forward to seeing you another time. Until then, everyone take care.