Caterpillar Stock: A Dividend Aristocrat with a Growth Engine, One-Stop Shop (NYSE:CAT)

introduction

It’s time to talk about Caterpillar (New York Stock Exchange:Cat)this is one of my most successful dividend (growth) investments.

Excluding dividends, my investment is currently up about 170%. This is an investment I started after the pandemic to add some inflation protection to my portfolio.

This performance resulted in a 10-year total return of over 330%, almost 100 points better than the already impressive S&P 500 performance.

In fact, Caterpillar has overcome many weaknesses as its stock price has diverged from key economic indicators such as the ISM Manufacturing Index.

The graph below compares the distance (%) that CAT stock is trading below its all-time high versus the ISM Manufacturing Index (black line).

CAT stock typically falls sharply when economic growth expectations weaken. That makes sense. After all, the company manufactures construction and mining equipment. It has a highly cyclical demand profile.

That said, using the chart above, CAT stock has decoupled from the ISM index, which failed to stay in expansion territory last month, as reported on May 1st when Bloomberg wrote: You can see that

The statistics show that U.S. manufacturing is struggling to gain traction, despite signs of optimism about the industry’s outlook earlier this year. Producers continue to contend with headwinds such as rising interest rates, rising input costs and weak overseas markets. – via bloomberg

The machinery industry was one of the seven industries that shrank.

my recent article on CAT was written with this title on February 12th “Yellow Machines, Green Investing – Caterpillar’s Bull Case in Today’s Market.”

Since then, the stock has returned 11%, outpacing the S&P 500’s return of 5%.

In this article, I revisit my bullish case and highlight new economic developments, the company’s latest earnings, and long-term tailwinds that could permanently support this Texas-based machinery giant. .

So let’s get started!

Strong earnings and shareholder returns despite headwinds

On April 25, Caterpillar reported its first quarter 2024 earnings. This was not long ago, during an earnings call, CEO Impleby announced higher operating margins, record adjusted earnings per share, and strong ME&T (machinery, energy, It’s still worth mentioning how optimistic the company was, starting by praising its achievements (transportation). ) Cash flow.

This was an impressive performance, as the company turned flat revenue into significantly higher profits and free cash flow.

In the current rising interest rate environment, that is not something investors can take for granted.

Additionally, as a result of these numbers, the company spent a record $5.1 billion on share buybacks and dividends during the quarter. This corresponds to approximately 3.0% of the current market capitalization.

• and 30th consecutive annual dividend increaseCAT is a Dividend Aristocrat.

After increasing its dividend by 8.3% on June 14, 2023, it now pays $1.30 per share every quarter. This corresponds to a yield of 1.5%. The five-year dividend CAGR is 8.6%.

The dividend is protected by a payout ratio of less than 25%, which is very healthy. It also benefits from his A-rated balance sheet at CAT.

Using Seeking Alpha Quant’s ratings, we see that CAT has a very favorable dividend scorecard, with scores in the A range in all segments except yield.

• Until now, CAT has Strong supporter of stock buybacksThis is because it increases the per-share value of the business and gives the company more flexibility in distributing funds.

In the past decade alone, CAT has repurchased more than one-fifth of its outstanding shares.

Returning to our financial performance, weak demand was the main reason we were unable to grow our total revenue in the first quarter, as seen below.

Volume declines resulted in a $684 million headwind, partially offset by the company’s pricing power.

Although the company’s energy sales increased, the resource and construction industries faced headwinds and were weighed down by lower sales volumes due to cyclical headwinds.

However, sales in areas such as autonomous mining vehicles continue to be strong and I am very bullish on this sector.

The company also invested in sustainable solutions, including an agreement with CRH, North America’s largest aggregate producer, to advance the development of zero-emissions solutions. This includes the deployment of battery electric off-highway trucks in the 70-100 tonne class.

The company also launched a hybrid energy storage solution for oil and gas operations designed to reduce fuel consumption, reduce total cost of ownership and reduce emissions.

With all this in mind, let’s take a closer look at what CAT expects from the future, and what this means for (potential) investors.

The future may be full of ups and downs

After a strong performance in 2023, demand for both non-residential and residential construction is expected to remain strong in North America.

• Nonresidential construction is expected to remain steady or increase slightly due to ongoing projects and government infrastructure initiatives.
• Home construction demand is expected to be flat to slightly down, but strong compared to historical standards.

These comments make sense, as anti-inflation laws and continued investment in supply chain infrastructure provide a healthy environment for demand, even compared to the grim comparisons of 2023.

Even better, these comments are confirmed by the latest macroeconomic figures.

Total construction spending fell 0.2% in MarchThis was the second decline in three months. Overall construction expenditure is 2024 is off to a slow start Monthly readings for the first quarter were -0.6%, 0.0%, and -0.2%. Housing spending slumped in March There will be pullbacks in both the single-family and multifamily segments. Non-housing spending increased by 0.2%, supported by public spending, particularly on infrastructure projects. – wells fargo (emphasis added)

That said, Caterpillar says that on the other side of the Pacific and Atlantic, economic conditions outside of China are softening, and demand for excavators over 10 tons in China remains low. That’s it.

Meanwhile, economic conditions in Europe are likely to remain weak, although strong construction activity in the Middle East provides some balance.

These developments are also expected in the company’s resource industry portfolio, as machine production is expected to decline due to weak demand for off-highway trucks. This also includes expected reductions in dealer inventory.

Additionally, the good news is that services revenue is expected to increase, supported by high utilization rates and aging fleets, driving the introduction of new products, including advanced products such as autonomous solutions.

In general, it must be said that as long as the prices of major commodities such as copper (pictured below – compared with CAT), gold, silver and other metals are in a strong upward trend, the demand trend will continue to be favorable.

Speaking of commodities, demand for oil and gas also remains high.

CAT remains optimistic about demand for reciprocating engines and oil and gas services and plans to invest aggressively in large engines to support demand in data centers, oil and gas, heavy mining trucks and distributed generation is.

At Caterpillar, a rival engine manufacturer, Sales of power generation diesel engines will increase to $6.4 billion in 2023, an increase of 29% from 2022, driven by data center sales. Sales of power generation engines increased by a further 26% in the first quarter of 2024.

caterpillar Plans to invest $725 million in Lafayetteto India, factory Expansion of production of large engines Used for power generation.

“Inside Caterpillar, we see power as a growth business.. A big driver of that is our data center business,” said Jason Kaiser, president of energy and transportation for the construction and mining equipment company. – wall street journal (emphasis added)

For the big picture, the company expects full-year ME&T free cash flow to be between $7.5 billion and $10 billion, representing 5.0% of its current market capitalization (at the midpoint).

This protects the dividend and leaves significant room for aggressive share buybacks.

Even better, since my February article, there has been an increase in analyst optimism.

At the time, analysts expected the company to generate EPS of $23.15 in 2026. Using his FactSet data in the chart below, that number comes to $24.50.

This year’s EPS is expected to increase by 2%, rather than flat. Next year’s growth rate is expected to be 6%, and in 2025 it may continue to grow at 7%.

All of these numbers are subject to change, but they represent the company’s potential in an environment where long-term tailwinds offset cyclical headwinds.

We expect these EPS numbers to improve significantly given stronger economic growth prospects in the US, Europe and Asia.

From a valuation perspective, CAT’s blended P/E of 16.4x is lower than its long-term normalized P/E of 17.1x.

The company’s fair price target is $419, based on a 17.1x multiple and expected 2026 EPS of $24.50. This is 19% above its current price and also above the $396 target it highlighted in February.

So I remain bullish on Caterpillar.

However, due to cyclical risks and recent gains, I believe it is best to add to CAT positions gradually in this economic environment, and I do not intend to initiate large positions at this level. there is no.

If stock prices decline a bit due to cyclical headwinds, investors’ averages may decline. If the stock price continues to rise, investors can get their foot in the door.

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Caterpillar has proven to be an outstanding performer in my portfolio despite economic headwinds, with impressive returns and increased distributions to shareholders.

The company’s strong earnings and consistent dividend growth highlight its resilience and strategic excellence.

Although the machinery sector faces cyclical challenges, CAT’s investments in sustainable solutions, new engines to meet growing power demands, and autonomous technologies represent a promising long-term opportunity in a long-term growth sector. I will provide a.

I remain cautious due to potential cyclical headwinds, but Caterpillar remains attractive for those looking to combine portfolio stability with growth potential by purchasing industrial exposure. It is an investment destination.

Advantages and disadvantages

Strong Points:

• Dividend growth: With 30 consecutive annual dividend increases, CAT is a reliable Dividend Aristocrat.
• Resilient returns: Despite the economic headwinds, CAT has shown solid earnings and free cash flow growth.
• Strategic investment: The company’s focus on sustainable solutions, power generation, and autonomous technologies positions it well for future growth.

Cons:

• Cyclical risk: The machinery sector is highly cyclical, and CAT’s results may be affected by economic downturns.
• Rating concerns: Although it remains below its long-term P/E ratio, the recent rally reflects a lot of good news.
• Economic headwinds: Weak demand in key markets such as China and Europe could impact future growth.
• Market sensitivity: In general, CAT’s stock price is volatile, so it’s important to keep this in mind before entering into a position.