The possibility of a looming trade war with China has resulted in heightened volatility in the stock market, particularly among shares of companies with a heavy exposure to China. A protracted period of tariffs could significantly derail companies that generate a significant portion of revenue from the Asian country's economy.
However, industrial giant Caterpillar Inc. (CAT, Financial) continues to report strong quarterly earnings, even with the uncertainty posed by recent trade concerns. The company is still seeing attractive growth due to steady economic growth in the U.S. and a renewed focus on growth in services.
At the same time, Caterpillar is paying out huge amounts of cash to shareholders. The company recent doled out a 20% dividend increase, making it one of the best dividend stocks right now.
A global powerhouse flexes its muscles
It wasn’t too long ago that Caterpillar was really struggling. As recently as 2016, the company’s fundamentals were deteriorating due to steep declines in the prices of commodities such as oil and precious metals. This was a major source of strain for Caterpillar, which manufactures Earth-moving equipment. The company services the construction industry, but also the energy and mining industries. Falling commodity prices caused orders to sink, taking down sales and profits along with it.
Fortunately, Caterpillar has enjoyed a resurgence in the last several years. Commodity prices eventually recovered, while the continued health of the housing market has fueled positive construction activity. In 2018, revenue increased 20% to nearly $55 billion. 2018 was an overall great year for Caterpillar as adjusted earnings per share jumped over 60%. For the full year, earnings of $11.22 per share set an annual record for the company. It also repurchased $3.8 billion worth of its own stock for the year.
Despite rising trade tensions, Caterpillar’s momentum has continued this year. In the first quarter, sales increased 5% while adjusted earnings per share grew 18.6% to $3.25. The company saw broad-based growth across its various industries. Construction industries saw revenue increase by 3% for the quarter, while revenue in energy and transportation increased less than 1%. Resource industries did the heavy lifting with segment sales growth of 18% for the quarter.
Caterpillar’s resource industries segment performed as well as it did thanks primarily to higher equipment demand and higher prices for its equipment. The mining and commodity industries remained healthy in the first quarter, while higher demand from non-residential construction customers also boosted its performance.
Not only did Caterpillar benefit from U.S. growth, but it also saw strong results abroad, even in many of the geographic regions that could be impacted by tariffs. For example, the company continued to perform well domestically with 7% revenue growth in the U.S. in terms of total machine, energy and equipment sales. Revenue increased 9% in Asia-Pacific and 9% in Latin America as well.
Caterpillar expects 2019 to be another strong year. At the midpoint of guidance, the company expects earnings per share growth of approximately 12% for the current year. The company should be able to grow earnings in the years ahead, even if a trade tensions worsen, thanks to its margin expansion efforts. Caterpillar typically generated adjusted operating margins of 7% to 15%. In 2018, however, the company’s adjusted operating margin rose to 13%. That number is expected to reach 16% in 2019. In addition to cost cuts to drive margin expansion, Caterpillar is leaning heavily on high-margin services. It expects to double its machine, energy and transportation services sales to $28 billion by 2026, from $14 billion in 2016.
Such strong results from Caterpillar have flowed directly to shareholders in the form of huge increases to the company’s capital allocation program.
Digging for dividend growth
Caterpillar recently massively increased its cash returns to shareholders. For example, the company increased its quarterly dividend by 20% earlier this month. The company is a Dividend Aristocrat, an exclusive group of 57 stocks in the S&P 500 Index with at least 25 consecutive years of dividend growth.
Caterpillar is an attractive dividend growth stock due to its many years of annual dividend increases. It also has a relatively high dividend yield of 2.7% right now, which is higher than the 2% average dividend yield of the broader S&P 500 Index. Dividends are likely to rise moving forward as the company forecasts high single-digit dividend increases over the next four years. With an expected dividend payout ratio below 30% for 2019, Caterpillar has plenty of room to continue increasing its dividend, even if earnings per share growth slows in the years ahead.
In addition to dividends, Caterpillar also returns cash to shareholders by repurchasing its own stock. Share repurchases totaled $751 million in the most recent quarter, and $3.8 billion in 2018. Share buybacks help companies boost earnings per share growth, as fewer shares outstanding makes every remaining share capture a higher portion of earnings. Caterpillar reduced its diluted share count by approximately 4.8% in the first quarter.
To be sure, the company is not immune from a global economic slowdown. Caterpillar suffered a significant earnings decline during the Great Recession years of 2008 and 2009. While it has the ability to defend itself against a temporary trade conflict, a full-blown global recession would derail the company’s growth prospects.
Final thoughts
Caterpillar has been one of the market’s strongest stocks in recent years. The company is firing on all cylinders due to rising demand for its machinery in the U.S. and around the world. It has a well-defined plan for continued growth through higher demand for machinery and equipment, as well as services.
Absent a deep global recession, Caterpillar should continue to generate strong returns for shareholders over the next several years thanks largely to high earnings per share growth and dividends. As a result, it is an attractive stock for dividend growth investors.
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