Shares of Caterpillar (CATFree Caterpillar Stock Report), a Dow-30 component and the world's largest maker of heavy equipment, traded higher after the company concluded 2012 with better-than-expected fourth-quarter results. December-period sales, at $16.08 billion, experienced a sharp decline from the year-earlier level of $17.24 billion, as flush machine inventories led dealers to curtail orders. Responding to earlier signs that stockpiles have grown to unfavorable levels, management successfully curtailed production and lowered inventory by a noteworthy $2.0 billion. Incremental operating profits resulting from those measures were substantial, and a lower-than-anticipated tax rate helped, as well. Although fourth-quarter share net of $1.91 came in below the $2.32 earned in the year-earlier period, that figure still eclipsed our $1.80 estimate.

The December-term bottom-line performance excluded a goodwill impairment charge of $580 million, or $0.87 per share, resulting from a 2012 acquisition. That acquisition triggered an internal investigation that revealed accounting irregularities at ERA Mining Machinery Limited, including subsidiary Zhengzhou Siwei Mechanical & Electrical Manufacturing Co., which led Caterpillar to overpay for the $800 million deal.

The company is cautious about 2013. In the latter stages of 2012, dealers reported a sharp increase in machine inventories, which left supplies well above their historical averages. Dealers have since curtailed order rates sharply, in an effort to reduce flush stockpiles, and nowhere is this trend more evident than in China. Though there are signs that industrial activity is picking up again in Asia's largest economy, China’s demand for mining and construction machinery has been weaker than in the recent past, which is taking a toll on equipment makers, especially Caterpillar. The company's excavator sales fell 40% in the most recent quarter, from the year-earlier period. Anticipating this development, management has lowered production at many facilities around the world. Moreover, all signs point toward a slow start to the current year.

Management's outlook for 2013 calls for sales between $60 billion and $68 billion, with share net expected to come in at $7.00-$9.00. Those relatively wide ranges reflect uncertainty in the market place. The mid-point of Caterpillar's top-line forecast would mark a decline of about $2.0 billion from 2012's final tally. Much of this decrease would probably be attributable to the Resource Industries segment, which is feeling the adverse effects of curtailed capital investments by mining customers.

The International Monetary Fund is projecting worldwide GDP growth of 3.5% in 2013, with the expectation of a 4.1% expansion in the following year. Total economic activity is a primary determinant of demand for machinery, which ought to take a turn for the better once elevated inventory levels subside. Moreover, orders should once again trickle in from all corners of the world.

Russia, which in 2012 finally gained admittance to the World Trade Organization, is expected to present a more open economy, one that needs equipment to modernize its transport, infrastructure, and agriculture industries. China’s stimulus programs, including construction of low-cost housing, as well as completion of agriculture and water resource projects, should prove to be a powerful catalyst.

Elsewhere, the American Energy & Infrastructure Jobs Act of 2012 should result in $260 billion of spending for the construction of roads, bridges, and highways across the U.S. over the next five years. Too, we expect purchases of equipment in Brazil to forge ahead, as its remains a popular destination for foreign direct investment. That nation is also determined to improve its infrastructure, as it prepares to host both the upcoming World Cup and Summer Olympic Games. Lastly, India, along with a number of emerging markets, should resume incentives to upgrade inefficient manufacturing and agriculture bases. The confluence of these factors suggests healthier demand for heavy equipment over the coming 3 to 5 years and a worthwhile total return for these modest-yielding shares.

About The CompanyCaterpillar Incorporated is the world’s largest producer of earthmoving equipment. Major global markets include road building, mining, logging, agriculture, petroleum, and general construction. Products include tractors, scrapers, graders, compactors, loaders, off-highway truck engines, and pipelayers. Also makes diesel & turbine engines and lift trucks. Foreign sales made up about 68% of the company’s total in 2011.

At the time of this article’s writing, the author did not have positions in any of the companies mentioned.