Heavy-equipment manufacturer Caterpillar (NYSE:CAT) has an impeccable record of annual dividend increases for the past 21 years, through up-and-down cycles. The recent plunge in oil prices to around $50 a barrel, though, has landed the company in a precarious situation. Caterpillar reportedly derives 12% to 15% of its revenue from supplying compressors, pumps, and gas turbines to oil companies.
The oil debacle lands on top of the prolonged depression in the mining equipment business that has been troubling the company for some time. Even so, there are factors that should give dividend investors confidence in the stock.
Tough times for Caterpillar
Caterpillar has three primary lines of equipment business: construction, resource industries (mining equipment), and energy and transportation (formerly power systems).
The slowing global mining sector has been a stumbling block for Caterpillar since 2013. The company's worldwide mining equipment sales have been down by double digits year over year in each of the last 12 months. The construction business helped Caterpillar offset the sales drop through the first half of 2014, but this segment has been pressured in the last six months as demand weakened in all markets other than North America.
The only saving grace was the energy and transportation business, which grew rapidly to become Caterpillar's largest and most profitable segment. Oil and gas, which makes up 30% ($6 billion-$7 billion) of the energy and transportation segment, has been crucial in that success.
Understandably, the sinking price of oil has become a concern for investors. Analysts at J.P. Morgan have said Caterpillar's 2015 results will be hurt by low demand from oil drillers and oil services companies, and an analyst from Edward Jones & Co. agreed, telling the Associated Press that oil prices will remain a concern for the company's 2015 earnings.
But the most shocking acknowledgement of the oil impact came when the company's management announced its 2015 outlook. This year, management expects companywide sales (including the financial arm) of about $50 billion and earnings of $4.60 per share, or $4.75 per share excluding restructuring costs. In 2014, Caterpillar generated sales of $55.2 billion and earnings of $5.88 per share, or $6.38 excluding restructuring costs.
How Caterpillar has braced itself
Caterpillar has prepared for its business headwinds through stringent cost-controlling measures that started in 2013. The company has resorted to temporary factory shutdowns and workforce reductions to optimize its cost structure. Consolidation of manufacturing facilities and moving facilities to low-cost areas are also part of the restructuring plan. These initiatives saved $1.2 billion in fiscal 2013. Though management has not yet disclosed the savings for 2014, its earlier expectation was for incremental gains in 2014 and 2015.
Dividend not threatened
Caterpillar's dividend yields a solid 3.3%, compared with the average 2% yield paid by S&P 500 companies. The company absorbed the 2009 recession and the 2013 revenue slump without giving investors a reason to complain. In fact, it paid a 15% higher dividend in 2013 even though its revenue and operating profit were lower by 15.5% and 32.2%, respectively, from prior-year levels. From 2008 through 2014, Caterpillar's dividend had a compound annual growth rate of 8.89%.
Caterpillar's payout ratio is still a modest 46%, so it can sustain dividends amid earnings volatility, which the behemoth might face in fiscal 2015 due to the oil price declines. This is supported by the equipment maker's healthy cash flow-generating ability.
In 2013, Caterpillar doubled its cash flow from operations to $10.2 billion as it reduced inventory and freed cash. In 2014, cash flow generation moderated to a still-healthy $8.1 billion. To adapt to the sales weakness that came with the mining slump, Caterpillar has considerably scaled back its capital expenditures over the last couple of years. This leaves extra cash that management could use to increase investor wealth. In 2014, the company paid $1.6 billion in dividends, up from $1.1 billion in 2013.
There's no doubting Caterpillar faces trouble from all quarters. But the company has rewarded its shareholders with dividend hikes and share buybacks in far more difficult times. Caterpillar's cost-cutting, reduced capital expenditures, healthy cash flow, and low payout ratio are solid reasons for dividend investors to stick with the company.