As China’s growth remains sluggish and as energy prices remain depressed, companies catering to the industrial, infrastructure and commodity sector are facing challenging times. While these challenging times are likely to continue in the foreseeable future, certain stocks are trading at attractive valuations and look good for long-term exposure. Caterpillar (CAT, Financial) is one such stock that has maintained excellent balance sheet health in difficult times and the company’s second-quarter results have several positives. This article discusses the positives and challenges to conclude that Caterpillar might be worth considering at current levels.
The first point that I want to discuss is the company’s guidance for FY15 and the valuation based on the guidance. Caterpillar reaffirmed that FY15 EPS will be in the range of $4.7 to $5.0 per share (excluding restructuring). Considering the mid-point of the guidance, Caterpillar expects FY15 EPS of $4.85 per share and this translates into a FY15 PE of 16.2.
In my view, these are attractive valuations for a company that provides a sustainable dividend of $3.08 per share. Further, the current Shiller PE ratio suggests that markets are trading at a PE of 26.7. Therefore, Caterpillar is trading at a significant discount to market valuations. I am not suggesting that the stock will rally any time soon, but I don’t see further downside in the stock.
The second point that I find positive from the quarterly results is the fact that Caterpillar intends to repurchase $1.5 billion in common stock in the third quarter of 2015. This is significant compared to $500 million in stock repurchase in the first half of 2015. The point here is that Caterpillar is keen to create shareholder value in difficult times and share repurchase is a good option considering the company’s strong balance sheet position. If the company’s operating cash flow remain robust, I expect robust share repurchase even in the fourth quarter of 2015.
I must mention here that the company’s revenue guidance for FY15 is down to $49 billion from an earlier $50 billion. However, I am not concerned on this point as macro economic factors were bound to impact revenues. At this point in time, I am more concerned about the cost control, sustained operating cash flows and value creation through dividends and share repurchase. All these factors are positive based on 2Q15 results and the outlook for the remainder of FY15.
I also wanted to focus on the company’s balance sheet position and the key point here is that Caterpillar has $7.8 billion in cash and $9.2 billion in current finance receivables. This translates into a liquidity position of $17 billion. In addition, Caterpillar generated an operating cash flow of $3.4 billion in 1H15. Even if the same OCF is considered for 2H15, Caterpillar has a total balance sheet cash position of $20 billion for the next 12 months. Considering this cash position outlook, I expect dividends to remain same or higher (board increased quarterly dividend by 10% in June 2015), I expect share repurchase to remain robust and I also expect Caterpillar to navigate the crisis with ease.
From a revenue turnaround perspective, China’s growth stabilization and renewed activity in the energy sector are the key factors. In my view, revenue growth turnaround is unlikely for the remainder of FY15 and seems unlikely even for FY16. I also believe that Latin America can be a significant revenue growth driver for Caterpillar in the years to come, but strong growth from Latin America will come only after reversal in commodity price.
However, as mentioned above, the key factor is margin expansion through cost control. In the last one year, Caterpillar has reduced global workforce by 4,831 in the last one year and I expect further reduction in workforce.
In conclusion, I expect Caterpillar’s sales to remain weak for the remainder of 2015, but I don’t expect the stock to trend lower. The stock is already trading at attractive valuations and offers a healthy dividend payout. In all probability, the dividend payout will increase in FY16 even if revenue stagnates. Therefore, the company remains an attractive dividend stock and the near-term EPS will marginally improve due to share repurchase as well. For investors who intend to invest with a time horizon of 5 years and are dividend seekers, Caterpillar is an attractive option to consider.
