Dividend Aristocrats

Study Caterpillar Stock; New Dividend Aristocrat of 2019

Caterpillar joins the prestigious group of S&P 500 Dividend Aristocrats in 2019. This index comprises of 57 blue chip stocks that have raised their dividends consecutively for  at least 25 years without missing even one. Caterpillar Stock graduated to Aristocrat status after raising its quarterly dividend from $0.86 to $1.03 per share in May 2019.

What’s more impressive is Caterpillar managed to raise its dividends through 2 huge recessions which include the 2000  technology bust and great financial crisis of 2008. This shows the resiliency of the company’s brands and products to weather economic downturns.

In this article, we provide a synopsis of Caterpillar’s business operations, analysis of latest financials including 2018 annual report, study of dividend payout ratio as well as long term performance versus the S&P 500 and XLI (S&P Industrials Sector ETF).

Business Synopsis

Caterpillar Inc. is the world’s largest manufacturer of construction and mining equipment which includes diesel and natural gas engines, electric locomotives, gas turbines, wheel dozers, monster mining trucks, asphalt pavers and bull-dozers, etc. Originally founded as Caterpillar Tractor Co. in 1925, the company employs 104,000 full time employees.

Its mission statement is to build basic infrastructure that enables a higher standard of living for people across the world. From paving roads to mining commodities or extracting fuels necessary to power global energy demand, Caterpillar is at the forefront of all infrastructure development.

For fiscal 2018, Caterpillar generated $54.72 billion in revenues, a 20.3% growth over 2017 revenues of $45.46 billion. The company earned $8.32 billion in operating profits, implying an operating margin of 15.2%.

Trading on the New York Stock Exchange, Caterpillar stock has a market capitalization of $79.3 billion as of November 2019 and pays a dividend yield of 2.87%. This yield is 100 basis points higher than the yield provided by the S&P 500,  which is 1.9%.

41% of the company’s sales and revenues are derived from United States while 59% from outside of the United States. This proves Caterpillar is a global powerhouse with diverse operations in 180 countries. Caterpillar has an impressive portfolio of over 4 million products sold globally.

Cat financial data

Largest markets for Caterpillar’s products are:

  1. North America at $25.62 billion in revenues.
  2. Asia/Pacific  at $12.48 billion.
  3. Europe, Africa and Middle East at $11.93 billion.
  4. Latin America at $4.7 billion.

Growth Outlook

As of 3rd Quarter 2019,  sales and revenues were $12.8 billion, down 6% year over year. The reason for this decline was Caterpillar dealers’ reducing their inventories by $1.2 billion. Sales dropped in all 3 primary geographies except for Latin America which was flat.

The company also reduced its profit per share outlook from $12.06 to $13.06 per share to $10.9 to $11.40 for full year 2019.

Cat full year 2019 outlook

Performance by Segment

Management conducts operations in 4 segments:

  1. Construction Industries
  2. Resource Industries
  3. Energy & Transportation and
  4. Financial Products.

Here is how each of these segments did for 3rd quarter, 2019.

Construction Industries – Sales decreased to $5.29 billion, down 7% or $394 million versus the same period last year (3rd quarter, 2018). Decrease is due to lower sales volumes as a result of dealer reducing inventories and lower demand coming from China.

Resources Industries – Sales decreased to $2.31 billion, down 12% or $327 million versus same period last year. Reasons for the decline are mining customers wary of an uncertain economy and commodities prices and lower thermal coal prices. Equipment demand for non-residential construction also experienced drop.

Energy & Transportation – Revenues dropped to $5.45 billion, down 2% or $103 million year over year. Slight drop in sales volume offset by lower bonus compensation are the reasons for this decline.

Financial Services – Revenues were $865 million, a growth of 2% or $20 million year over year. The slight increase was due to higher interest rates for equipment financing in North America.

Cyclical Nature of the Business

Caterpillar’s revenues rise when global economy is growing as measured by increased investment in construction, oil and gas and mining. Sales and revenues dropped from $55.18 billion in 2014 to $38.54 billion in 2016 due to the drop in oil prices from upwards of $100 to as low as $28 per barrel.

The stock was also very volatile in 2015 and 2016 when it dropped from a high of $94 to as low as $50, representing a 46% drop.

Dividend History, Sustainability and Payout Ratio

Caterpillar stock is a member of the S&P 500 Dividend Aristocrats Index, an elite group of companies that have not only paid dividends for at least 25 years, but consecutively raised them each year as well. Caterpillar has raised its dividend from $0.37 per share in 1996 to $3.28 per share in 2018, a stunning 886% growth in 22 years.

This amounts to a compounded annual growth rate (CAGR) of 10.4%. Over the last 5 years, the company has grown its dividend by an average of 7.77% annualized, which is lower than the threshold of 10% that we like, however it is still respectable.

Caterpillar dividend history chart

Below is a chart showing the annual percentage growth in Caterpillar’s dividend over the prior year. We can see that even during the great financial crisis of 2008 to 2010, Caterpillar still managed to raise its dividend by 18% in 2008, 7.7% in 2009 and 2.4% in 2010.

Caterpillar dividend growth % year over year

Measuring the Dividend Payout Ratio

Caterpillar is a dividend aristocrat stock because it has raised its dividend each year for the last 25 years. How awesome is it for investors to be able to invest in a company that helps the world build essential infrastructure while collecting growing dividend checks each month?

Lets examine the the dividend payout ratio for Caterpillar stock. Dividend Payout Ratio measures how much of a company’s free cash flow is paid out in the form of dividends. Free cash flow is the cash a company generates from its daily operating activities minus capital expenditures like investing in new plants or equipment.

Free cash flow is calculated from the statement of cash flows, and is not artificially modified using accounting rules or non-cash expenses like depreciation, amortization, fair value revaluations, etc.

In Caterpillar’s 2018 annual report, cash generated from operating activities is $6.558 billion. Capital expenditures came in at $2.916 billion. Let’s calculate the free cash flow.

Free Cash Flow = Cash from Operations – Capital Expenditures

= $6.558 billion – $2.916 billion

Free Cash Flow = $3.642 billion

Dividends Paid in 2018 = $1.951 billion

Dividend Payout Ratio = Total Dividends Paid / Free Cash Flow

= $1.951 billion / $3.642 billion

Dividend Payout Ratio = 54%

A dividend payout ratio of 54% is sustainable and means the dividend will grow over time as the company is committed to rewarding shareholders.

Performance of Caterpillar (CAT) Over the Long Term

Below is a long term monthly chart of Caterpillar Stock. It has grown from $7 in January 1980 to $143 in November 2019, representing an excellent return of 2042% in 39 years. This is a compounded annual growth rate (CAGR) of 8%.

Owning this stock is not for the faint of heart because during economic downturns, it loses more than 50% of its value. As an example, during the great financial crisis of 2008, Caterpillar stock dropped from $80 to as low as $20; a 75% loss.

Caterpillar Stock Long Term Price Chart

Caterpillar (CAT) Performance and Valuation versus S&P 500 and XLI

In the chart below, Caterpillar is in red line while S&P 500 is in blue. Over the last 10 years, Caterpillar has gained 221.24% outperforming the S&P 500 by 34.6%. The S&P 500 gained 184.8% during this period.

In 2016 when the price of crude oil crashed to as low as $27 per barrel, Caterpillar Stock plunged and great under performed the S&P 500.

However during oil’s recovery in 2017, the stock outperformed. As of November 2019, Caterpillar has gained 13.6% year to date and has under performed S&P 500 which has gained 22.7%.

Stock Valuation

Caterpillar trades at a forward price to earnings ratio (forward PE) of 12.9. This is cheaper than the S&P 500 which trades at 17.6 times forward 2019 earnings.

This essentially means for every $1 that Caterpillar earns in net income, investors are willing to pay $12.9 for the right to own the stock. One reason for the low valuation is huge long term debt on the company’s balance sheet.

Caterpillar Stock versus S&P 500

Executive Summary

Here is what we like and don’t like about Caterpillar stock.

Likes

  • The company is trading at a forward price to earnings ratio of 12.9 which is quite cheap.
  • The stock currently pays a dividend yield of 2.9%, about 100 basis points higher than the S&P 500.
  • Growing dividends at 7.77% annually over the last 5 years.
  • Dividend payout ratio of just 54% leaving room for future dividend raises.

Dislikes

  • Long term debt of $36.211 billion including a $7 billion liability for post employment benefits.
Market Capitalization $78.21 billion
Dividend Yield 2.91%
Forward PE Ratio 12.9 times earnings
Dividend Growth (5 Year Avg.) 7.77%
Dividend Payout Ratio 54%
EPS Growth (5 Year Avg.) 11.9%
2018 Revenues $54.722 billion
Gross Margin 32%
Net Margin 10.7%

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