Caterpillar, CAT

  • Caterpillar (CAT) experienced a decline of 42% to net income in Q1 2020 vs. Q1 2019, primarily due to lower sales volume.
  • In addition, CAT has been able to reduce operating expenses by $2 billion, and investors may see a more efficient operation going forward.
  • CAT is labeled as a dividend aristocrat, yet, no dividend increase this past quarter and recent performance w/ the pandemic may disrupt their growth streak.

Caterpillar: Background

Caterpillar (CAT) has technically been around for almost 100 years, dating back to 1925.  We have all seen their machines on construction sites.  However, for those that may not know, Caterpillar is the worlds largest construction equipment manufacturer.

Many businesses have persevered through the coronavirus pandemic.  However, manufacturing was not one that could dodge the sweeping bullet. So much so, that Caterpillar, similar to other businesses, withdrew 2020 guidance and their CEO also stated, “The impact of Covid-19 on our business has been significantly more severe and chaotic than any cyclical downturn we had envisioned.” (Source: Bloomberg).

Additionally, from analysts in a Barrons article, about 50% of their cash flow is from the Oil & Gas industry.  Now, Q1 of 2020, revenues in the industry represent ~44% of revenue, therefore, that comment is definitely serious.  It is serious because when the price per barrel falls to record lows and with businesses shut down, the oil & gas industry does not have the free cash flow and revenues for projects, drilling and exploration; which impacts Caterpillar’s business.  Speaking of Q1 2020, let’s look at Caterpillar’s results, to see if their performance can show a glimpse into the future, which can impact expected earnings for the remainder of the year.

(adsbygoogle = window.adsbygoogle || []).push({}); Caterpillar’s Q1 2020 Financial Condition & Performance

Caterpillar released their results in April & May 2020 for their first quarter.  You will see there were positive signs, such as, “75% of the company’s primary product facilities continue to operate” but that is coupled with negative signs, such as sales and revenue experienced a 21% decline, year over year.  Due to mixed results, Caterpillar suspended 2020 guidance, as stated earlier.

revenue Performance:

Caterpillar’s top-line revenue was down $2.8 billion, from $13.47 billion in Q1 2019 to $10.6 billion in Q1 2020.  Energy & transportation declined by $900 million in that same time period, representing 32% of the revenue decline.  One has to also keep in mind that these negative impacts may be minor, compared to the beginning of Q2 2020, as the U.S. was only locked down for the better part of the last two weeks of Q1.  This compares to the first month and a half in Q2 2020. Therefore, I anticipate revenue to continue to decline from Q1 of 2020 into Q2 2020.

Net income, however, dropped even further.  Net income dropped from $1.9 billion to $1.1 billion or a 42% decline. The reason why net income was down more is due to operating expenses did not decline as fast as revenue. For instance, SG&A only declined 15% from $1.3 billion to $1.1 billion.  I anticipate that there were heavier layoffs and temporary work suspension in Q2 vs. Q1 and that expenses will continue to decrease in Q2.

The operating expenses will decline more in Q2, than Q1, to catch up to the decline in revenue.  I foresee that net income will turn better starting in Q3.

Further, Caterpillar has increased their flexibility.  This is demonstrated by know they have, as well as mentioning in their press release, the credit facility of up to $10 billion.  We can also look at their balance sheet for continued flexibility during this uncertain time.

balance sheet review:

During the pandemic and uncertainty, having a liquid balance sheet is key.  This allows you to be able to pay current obligations and service payments owed to others.  At the end of Q1 2020, Caterpillar had a current ratio of 1.41x (current assets of $37.6 billion over current liabilities of $26.5 billion).  I use 1x as a barometer for being liquid and they achieve that metric. F urther, from looking at their quick ratio (which removes inventory from the Current Assets in the Current Ratio equation), they still achieve a 0.97x or almost 1x. Typically, I want above 0.75x and Caterpillar achieves this.  Naturally, the quick ratio is typically less than the current ratio, which is the case here.

Therefore, Caterpillar is liquid enough to be flexible in operations and has more than sufficient assets currently on hand to me current obligations.

As a dividend investor, the financial performance and balance sheet are key. However, not only are those metrics important, their dividend metrics are critical to making an investment decision, especially if it’s to be in a dividend portfolio.  Time to run them through the legendary Dividend Diplomat Stock Screener!

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If you don’t know already, we keep the stock screener metrics to THREE SIMPLE items.  They are:

  1. Price to Earnings Ratio – We look for a price to earnings ratio < than the overall Stock Market.
  2. Payout Ratio – We aim for a payout ratio between of less than 60%.
  3. Dividend Growth – We like to see history of dividend growth in a company.

See the video below, for further details and explanation.  If you don’t like to watch videos – see our Dividend Diplomat Stock Screener page!

price to earnings ratio:

Caterpillar’s stock price is $127.46 as of the close on June 19, 2020. The price to earnings (P/E) ratio can show a sign of under or over valuation. I use forward earnings, as the year is mid-way through, and I base my investment decisions about how they will perform in the future. In this case, analysts are projecting earnings of $7.05 for the year 2021. Therefore, the P/E ratio is 18.07.  Currently, the S&P 500 P/E Ratio is at 22.90. Caterpillar shows a slight sign of undervaluation vs. the overall market, even after the last two months of stock price surges since the bottom in March.

Dividend Payout Ratio:

In addition, as a dividend investor, the safety of the dividend is crucial, especially during troubling and uncertain time periods. Caterpillar currently pays $4.12 in dividends per year. Given expected earnings of $7.05 in 2021, the payout ratio is 59%. Caterpillar’s payout ratio is not typically this high. If we happen to look at Q1’s earnings of $1.98 per share, if earnings were half of that for the remainder of the year, Caterpillar would be topped out at ~100%. Therefore, the dividend payout ratio was put through a stress test in that scenario and they may be able to just cover the dividend if that happens in 2020.

Dividend Growth:

Another critical component as a dividend investor is the combination of dividend yield and dividend growth. At a price point of $127.46 with a dividend of $4.12, the dividend yield is 3.23%.  Currently, the S&P 500 yields 1.87%. Caterpillar will pay you more to own their shares vs. the entire market.  However, that is not all that matters when it comes to the dividend. The dividend growth rate is critical.

Caterpillar has a stellar dividend growth rate of 10.44% over the last 3 years, on average, and is 8.26% over the last 5 years, on average. When you pair that dividend growth rate with the current dividend yield, the combination is strong, as it eclipses double digits. Caterpillar has an above average dividend yield with an above average dividend growth rate.

Overall, the yield is above average. However, if the stressed scenario of 50% earnings per share does occur for the remainder of the year, Caterpillar would be just able to pay their dividend but dividend growth may not be likely.  Further, Caterpillar is a dividend aristocrat!

See the video below, for further details and explanation on Dividend Aristocrats.  However, if you’d rather read, see our Dividend Aristocrat article!

Caterpillar Investment Conclusion

Caterpillar does have a significant reliance on the oil & gas industry. Given the current price per barrel is still under $40 and that many companies suspended projects for at least the year, this leaves Caterpillar’s clients and projects to the sideline.

Though the government deemed Caterpillar’s business as essential, Caterpillar was not operating at 100% (management stated 75% during their earnings release). In addition, my expectation is that revenue will continue to decline into Q2, as there is more time at a depressed level during the current quarter vs. Q1. Due to this, I don’t foresee performance improving into Q2 from Q1.

(adsbygoogle = window.adsbygoogle || []).push({}); As a dividend investor, I do not necessarily believe their dividend is at risk of cut. However, as a dividend investor you want dividend growth. They announced their dividend and decided to keep it the same as prior quarter.  I do not see them increasing their dividend, giving the lack of certainty and potential impacts to their top-line and bottom-line metrics (revenue and net income).

Therefore, at this price, I do not plan on investing into Caterpillar. Given the yield is above the S&P 500 at 3.23%, I believe there is additional risk that warrants a higher yield, as in my stressed scenario of a 50% earnings reduction, the dividend payout will struggle to be covered.  Further, the forward price to earnings is too high/close to the S&P 500 for my appetite and I believe there to be other undervalued dividend investments out there.

However, what do YOU think, the reader?  Do you find value in Caterpillar right now?  Are you waiting to buy at lower prices?  Share your thoughts below!  As always, thanks for stopping by, good luck and happy investing!


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