What are we to think of Caterpillar Inc. (CAT, Financial), a company that is considered a barometer of global economic growth (or lack thereof)? We cannot foresee the future, of course, but we can look back at what Caterpillar has achieved in the past to guide our expectations for the coming years.
Some of the most significant macro events of the past few years include the trade war between the U.S. and China and the Covid-19 pandemic, both resulting in economic contraction worldwide. Those events show up in Caterpillar's 10-year price chart:
Caterpillar is a major industrial company, making heavy-duty equipment. It operates with three major reporting segments (as shown in its 2019 Data Book): excavation, earthmoving and building construction projects.
In its 10-K for 2019, the company reported, "With 2019 sales and revenues of $53.800 billion, Caterpillar is the world's leading manufacturer of construction and mining equipment, diesel and natural gas engines, industrial gas turbines and diesel-electric locomotives."
With the economic slowdown that began late in the first quarter, its results suffered in the second quarter:
The company expects more of the same in the third quarter. But, in the longer-term, we should be able to expect more from Caterpillar. As Robert Stephens pointed out in a GuruFocus article last year, the company has some promising technology in development, such as electric vehicles, autonomous-driving vehicles and digital support for customers:
"It has over 200 autonomous trucks that have together accumulated 30 million miles of autonomous driving. This is more than twice the experience in autonomous operations of any car manufacturer, which suggests the company is well-placed to provide improved efficiency to its customers."
Most importantly, these innovations will reduce their customers' costs, making them more productive. Those promises for future growth go along with respectable fundamentals.
Financial strength
Overall, the company gets an average score for financial strength, which reflects Caterpillar's growing long-term debt. Still, the leverage is well under control. As we can see, interest coverage is more than 13 times, meaning the company earns enough operating income to pay its interest expenses 13 times over.
The Piotroski F-Score is in the middle of the range, which is where we expect financially stable companies to be.
The Altman Z-Score is more troubling. As GuruFocus explains, "Caterpillar has a Altman Z-Score of 2.47, indicating it is in Grey Zones. This implies that Caterpillar is in some kind of financial stress. If it is below 1.81, the company may face bankruptcy risk."
The return on invested capital (ROIC) is greater than the weighted average cost of capital (WACC), meaning the that management is delivering more than it is spending. The company is still profitable.
Profitability
There is lots of green on the profitability table, which is encouraging for potential investors. It means Caterpillar is outperforming its peers, competitors and its own history. While it has headwinds in trade issues and the current slowdown, so do most of its competitors, and it is out-managing them.
The below chart shows the trajectories of the annual operating margin and net margin over the past decade:
Its return on equity is strong and its return on assets is keeping up with other players in the industry.
The three-year revenue growth rate is very good, but the three-year Ebitda growth rate is even better. When Ebitda is growing faster than revenue, we know the company is becoming more efficient.
Valuation
Both the price-earnings ratio and the PEG ratio indicate some overvaluation. The price-earnings ratio is in the middle of the industry pack, while also being lower than it has typically been in Caterpillar's past.
Similarly, the PEG ratio (which is the price-earnings ratio divided by the growth in profitability as measured by the past five years of Ebitda) show it is not a bargain. A stock with a PEG ratio of 1.00 is considered fair-valued, while a higher number indicates overvaluation.
Dividend and share buybacks
Caterpillar offers a dividend yield that is nearly a full percentage point above the S&P 500 average. Here's how it has been affected by the share price:
Below is the company's history of dividends per share:
The company explained its updated dividend policy in the 10-K for 2019:
"Each quarter, our Board of Directors reviews the company's dividend for the applicable quarter. The Board evaluates the financial condition of the company and considers the economic outlook, corporate cash flow, the company's liquidity needs, and the health and stability of global credit markets to determine whether to maintain or change the quarterly dividend."
The dividend payout ratio is 55%, which is reasonable for a mature company and means it is keeping 45% of its free cash flow for growth and 55% for dividends.
The dividend has grown by 7.1% per year on average over the past three years, and that helps lift the five-year yield-on-cost to 3.8%. In context, the yield-on-cost refers to how much an investor might expect to receive per year, on average, over the next five years. It is based on the presumption the investor buys and holds for five years, and that the company continues to increase the dividend at the same rate as it has for the previous five years.
The share repurchase ratio over the past three years has averaged 2.1. This 10-year chart shows how the company has reduced its share count:
Gurus
Fourteen popular investing gurus own shares of the company, and gurus have been net buyers of the stock in recent quarters:
The biggest investor among the gurus at the end of the second quarter was Dodge & Cox, which held 47,473,473 shares, representing a 10.40% stake in Caterpillar and accounting for 2.73% of its assets under management. The firm added 7.73% to its holding in the quarter.
Chris Davis (Trades, Portfolio) of Davis Selected Advisors owned 16,159,701 shares, after adding 1.03% during the quarter.
Steve Mandel (Trades, Portfolio) of Lone Pine Capital established a new position during the quarter, giving him the third-largest stake with 10,278,292 shares.
Conclusion
Caterpillar Inc. is suffering some mild setbacks because of adverse economic circumstances around the globe. But if we take a longer perspective, it seems likely the firm will rebound and perform well for investors, assuming the world economy recovers.
This company has good financial strength and profitability. The dividend is okay and the share price is considered modestly overvalued. All things considered, I think Caterpillar has the management team, and probably the culture, to make the most of their innovative products when the economy picks up again.
Value investors who can live with a modest amount of leverage may be interested, but will want to wait for a better price, in my opinion. Growth investors may give Caterpillar their attention if they feel that rebound is coming soon. Income investors may want to look elsewhere for a better yield and a more promising yield-on-cost.
Disclosure: I do not own shares in any companies named in this article.
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