Is Caterpillar Adding Value to its Shareholders?

Caterpillar is facing tough headwinds in its resource industries sector. As the mining industry is not looking bright for some more quarters, Caterpillar’s financial strength is under scrutiny.

Jul 22, 2014 at 4:55PM

Caterpillar (NYSE:CAT), the global titan in heavy equipment machinery, has truly remained a dividend paying stock for the last twenty years. Though the company has been experiencing tough times from the last few quarters, it has continuously rewarded the investors through dividends and buybacks.

In the words of legendary Warren Buffet – "Cash combined with courage in a time of crisis is priceless." This saying is a perfect fit for Caterpillar which has maintained its cash reserves even during crisis periods to deliver value to the investors. Having said this, for a company prone to market cyclicality, a few issues do arise. Can the company sustain this trend in the coming future? Is the company in a position to sustain its dividend? What are its key financial strengths that aid in adding ultimate value to the shareholders? Let's assess the company's key financial metrics to get to the final answers.

Revenue and earnings growth
Caterpillar's revenue rose substantially year over year from 2009 until 2012, but in the last year the revenue plunged due to the slump in the mining industry. The decline affected revenue from Caterpillar's resource industries segment (which caters to mining), as sales of high margin mining equipment took a severe hit. However, the consistent performance of the construction and power segments in 2013 averted the dramatic revenue slide. 

There lies the beauty of Caterpillar's business-it operates in three diverse segments, and one segment's weakness can be offset by strength in other segments. And this is the crux of the story if we look back at the past financials of Caterpillar. In 2013, year over year total sales dropped by 16%, but this nosedive could have been higher if there was no diversification of business. 

Analysts estimate that despite a lag in the mining industry, the company's revenue will grow at 1% in fiscal 2014 and 5.9% in fiscal 2015. This is primarily attributable to improved construction equipment sales in North America and China.

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Source: Data from Morningstar; chart made by author

The earnings of Caterpillar have improved over the past years. Though it dipped in 2013 due to compressed margins, in the first quarter of 2014 earnings rose 10% to $1.44 a share from $1.31 reported in the similar quarter last year. Reduction of research and administrative expenses by $1.2 billion, and employee headcount by 9,700 in the last year positively affected the first quarter earnings of this fiscal year. 

Bloomberg analysts were expecting earnings per share of $5.81 for this full year. These projections hinged on an anticipated construction boom in the global markets as construction equipment demand is projected to expand at a CAGR of 7.3% from $102.3 billion in 2010 to around $145.3 billion by 2015.  

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Source: Data from Morningstar; chart made by author

Steady cash flow generation
Free cash flow is an important performance indicator as dividends get distributed, repurchases are initiated and new investments are made from this cash component.

While Caterpillar has consistently generated free cash, the company has experienced major swings year to year. True, the company has been able to generate positive cash flow every year for the past five years, however small, even in 2012 when the company's poor inventory management ate away at free cash flow generation.

Financials

Source: Data from Morningstar; chart made by author

Stable dividend payout
The payout ratio gives an idea on how well the company earnings support the dividend payments. A stable dividend payout ratio reflects a solid dividend policy maintained by the management which helps in creating incremental value for the shareholders. 

Caterpillar has been a stable dividend yielding stock and its quarterly dividend has increased gradually from $0.0875 per share in 1996 to $0.60 per share by 2013. In this fiscal first quarter the company has declared a dividend payout of $0.60 per share which convinced investors perturbed with the dwindling mining industry prospects. The company has also maintained regular dividend payout on an annual basis over the past years. The company has also announced an interim dividend in June this year which is a 17% hike to 0.70 per share.

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Source: Data from Morningstar; chart made by author

Caterpillar has been modest in its dividend payout for the previous ten years averaging to around 26.85%, in terms of the payout ratio.  Caterpillar's focus is more on steady regular payouts than on high payouts. Thus it has always rewarded its shareholders' with dividends even when the earnings were softer. As Caterpillar maintains stable payouts almost every quarter, it can further exercise control over its future dividend payouts. From 1998 till date, the cash dividend paid to the investors has more than tripled.

The company is not restricted to dividend payouts alone; it also periodically repurchases stock. Recently it has entered into an agreement for accelerated stock repurchase of $1.7 billion. This is like the cherry on top of the sundae for its investors.

Foolish takeaway
Caterpillar's management has been prudent while adding value to its shareholders through dividends and stock repurchases. The stability in cash flow, healthy dividend record and regular stock repurchase program augurs well for the company. With this track record and a stable financial outlook, shareholders can stay calm in the upcoming quarters as well.

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