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Caterpillar's Improving Business Makes It a Solid Long-Term Investment

July 10, 2014 | About:
kcpl

kcpl

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Caterpillar (CAT), the construction and mining equipment company, has delivered an impressive performance so far this year. The stock is up about 13% after the company posted strong results in the recent quarter. The efficient cost control measures and an increase in demand for building equipment are driving its prospects. As a result, Caterpillar was able to negate the effects of a downbeat mining industry.

Staying positive

Caterpillar is focused on reducing costs to turnaround its business. Driven by favorable material costs, lower incentive pay, and short-term actions such as closure of plants, layoffs, and certain restructuring moves, Caterpillar is improving.

Caterpillar serves a wide range of industries. Its sales in construction and power systems were comparatively better, as the downfall in sales was small. Moreover, Caterpillar has improved its market position with strong traction in China with excavators.

Besides, Caterpillar is pleased to see improvements in the world economy, especially in construction and power systems that are expected to grow by 5% each this year. However, the company expects its resource segment to slip about 10%, despite the improvement in the economic climate and strong production at mines, which is not a healthy sign for investors.

Caterpillar, on the other hand, is busy in restructuring its business this year. It is in the process of reshuffling its Gosselies, Belgium, facility through various initiatives such as reshaping the supply base for more efficient sourcing, improving factory efficiencies, and workforce reductions that should increase its operation efficiency and yield better results going forward.

Also, these initiatives will enhance the production of its European manufacturing footprint, as the company now focuses on its current Gosselies operations on final machines assembly, test, and paint, with limited component and fabrication operations.

However, Caterpillar's order rates as compared sales in the first quarter were close to equilibrium. As a result, the order backlog was fairly close to being flat with that seen in year-end 2013. Since Caterpillar is producing more this year, it's seeing an increase in efficiency. Inventory reductions from last year had resulted in negative inventory absorption impacts on the profit, but this year, this phenomenon has diminished.

Investor-friendly moves

Caterpillar pays a strong dividend to its shareholders. It had also repurchased $1.7 billion of stock in the previous quarter, as the company had a record operating cash flow of $9 billion.

In addition, Caterpillar had also raised its quarterly dividend by 15%. Considering that Caterpillar’s payout ratio is still at 30%, strong cash flow generation going forward as a result of cost-reductions should lead to further dividend increases. In fact, Caterpillar has authorized a new $10 billion share repurchase program, which should support its earnings and deliver returns to investors.

Fundamentals

Caterpillar has a trailing P/E ratio of 16.84 and a forward P/E ratio 14.08. This indicates that analysts are hopeful about an improvement in earnings going forward due to a slight improvement in the business and cost reductions. Moreover, Caterpillar’s earnings are expected to grow at an annual rate of 13.45% for the next five years, which makes an investment in the stock a good proposition at its current valuation levels.

Conclusion

Caterpillar looks a better prospect now as the company is focusing on creating efficient operations that should drive its growth going forward. In addition, the dividend-paying nature and focus on share buybacks makes Caterpillar a solid investment. So, even if Caterpillar manages to put in a bad earnings report, it could be a good investment for the long run.


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