The U.S. stock market is reaching new highs, and a select group is responsible for a bulk of the gains. The rally in the Dow Jones Industrial Average is being led in large part by industrials.
Industrials are some of the most economically-sensitive stocks in the market. They are highly dependent on economic growth.
With the outcome of the U.S. election, the market rally could be responding to anticipation of higher infrastructure spending. Any potential boost to domestic infrastructure like roads and bridges would be a significant stimulus to the nation’s largest industrial manufacturers.
This article will discuss three stocks in particular that stand to benefit from greater infrastructure spending.
All three are high quality dividend growth stocks with long dividend histories. Two are, in fact, Dividend Achievers – stocks with 10-plus consecutive years of dividend increases. You can see the full list of all 273 Dividend Achievers here.
Caterpillar (CAT, Financial)
Caterpillar's stock is up 16% in just the past one month. Caterpillar could use a boost because this year has been a rough one for the company.
Sales in the third quarter declined 16% from the same period last year. In addition, operating expenses are rising due to a significant company restructuring and weak pricing.
Source: Credit Suisse Industrials Conference presentation, page 11
Collectively, this caused operating profit to decline 48% last quarter, year over year. The results would have been even worse if not for a huge cost-cutting effort.
Caterpillar cut manufacturing costs by $234 million in the third quarter. It also cut period costs by $420 million.
This will not help revenue, which is expected to drop significantly in 2016. The company expects full-year revenue to decline 29% to $39 billion.
These cost cuts are helping Caterpillar at least stay profitable. Management forecasts $3.25 in EPS this year, not including restructuring costs.
The decline in precious metals prices has reduced demand for Caterpillar’s heavy machinery and Earth-moving equipment.
Source: Credit Suisse Industrials Conference presentation, page 11
Caterpillar would be a major beneficiary of any fiscal stimulus.
Caterpillar is a solid stock for dividends. It offers a 3.1% dividend yield and has a long track record of dividends as a Dividend Achiever.
Furthermore, Caterpillar has paid higher annual dividends to shareholders for 23 years in a row. It has paid a dividend each year since it was formed in 1925.
Deere & Company (DE, Financial)
Deere, like Caterpillar, is a manufacturer of heavy equipment. They are both involved in the construction industry.
The difference between the two companies is that Caterpillar caters mostly to the mining industry, while Deere is focused more on agricultural equipment.
Deere’s product lineup predominantly includes tractors, mowers and planting and seeding equipment. The company is organized into two operating segments:
- Agriculture and Turf (79% of sales)
- Construction and Forestry (21% of sales)
Deere is struggling because of the steep drop in farming incomes across the world. This was caused by a decline in agricultural commodities like corn.
Global farm incomes are falling, which means there is less money for farmers to update their agricultural equipment. This has had a clear impact on Deere’s bottom line.
Deere recently concluded its fiscal year, and the results were ugly. Total revenue declined 8% to $26.6 billion.
EPS declined 17% for fiscal 2016 to $4.81. This was due to the revenue decline as well as higher restructuring expense.
Deere could benefit from higher infrastructure spending. Construction spending in the U.S., in both the private and government sector, has stagnated for many years.
Source: Market Fundamentals presentation, page 13
This has had a distinct impact on Deere, which has suffered with falling cash flow for several years. Operating cash flow declined 31% in 2015. Expectations are for operating cash flow to decline another 6% this year and 14% next year.
Source: Fourth Quarter earnings presentation, page 26
Despite the pressures facing the company, Deere is still profitable and frequently raises its dividend. Like Caterpillar, Deere is a Dividend Achiever.
Deere's stock has a mix of value and income potential. Shares trade for a price-to-earnings ratio of 21. It is cheaper than the S&P 500 Index, which has a price-to-earnings ratio of 26.
And, Deere's stock has a 2.3% dividend yield.
Union Pacific (UNP, Financial)
Lastly, the railroads could be big winners from growth in U.S. infrastructure spending. Union Pacific shares have gained 12% in the past one month.
Railroads transport all sorts of goods around the country. They are highly sensitive to fluctuations in economic conditions, and are widely viewed as economic bellwethers.
Union Pacific is one of the biggest railroads in the U.S. Its motto is “Building America”, which makes it an obvious pick as a play on infrastructure.
The company’s freight business has a large and diverse customer base:
- Agricultural Products (19% of sales)
- Automotive (11% of sales)
- Chemicals (19% of sales)
- Coal (13% of sales)
- Industrial Products (18% of sales)
- Intermodal (20% of sales)
Similar to Caterpillar and Deere, Union Pacific has been side-swiped by the drop in commodities. All six operating segments posted revenue declines over the first three quarters of 2016.
Not surprisingly, coal is the worst-performing area for the company.
Source: Third Quarter Earnings presentation, page 4
The boom in domestic natural gas production has incenvitized industrial customers to switch from coal to natural gas.
One of the best-performing segments for Union Pacific is agricultural products.
Source: Third Quarter Earnings presentation, page 3
Overall net revenue has declined 11% in the first nine months of the year. Union Pacific has suffered from the combination of an 8% decline in carloads, as well as a 3% decline in average revenue per car.
The good news is that Union Pacific is still cash flow-positive. It generated $5.4 billion of operating cash flow over the first nine months of 2016.
It uses some of its cash flow to reward shareholders with dividends. Union Pacific stock has a 2.3% dividend yield.
The company has a strong brand, which has enabled it to navigate many difficult periods. Union Pacific has paid dividends on its common stock for 117 years. It recently increased its dividend by 10%.
If higher infrastructure spending is in the cards, Union Pacific should have little trouble maintaining its dividend growth going forward.
Disclosure: I am not long any of the stocks mentioned in this article.
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