- The mining index is rallying hard after what seems like a bottom. This is bullish for Caterpillar.
- Oil prices will eventually rally and Caterpillar's balance sheet is far healthier than some of the large-cap companies in this sector.
- Dividend investors will keep the stock elevated. Payout ratio is relatively low for a commodity based company.
I have been watching Caterpillar (NYSE:CAT) closely over the last few weeks especially after its fourth quarter earnings results and the big move in the gold mining index. The gold mining index has had a monster move since the 20th of January (46%+) and Caterpillar has also managed to participate in what may be the up move from a firm bottom in the mining index (see chart).
I believe 12% was a good return for Caterpillar over the last 12 days or so considering its "Resource Industries" make up under 20% of its revenues. In fact, Caterpillar's resource industries division made $1.83 billion last quarter, of the total of $11.03 billion in revenues. If metals continue to rally in the near term, expect Caterpillar stock to follow suit at a lower percentage. What also is acting as a tailwind for the stock at present is the recent weakness in the dollar index, due to weak economic data pertaining to the U.S. services sector, along with dovish comments from William Dudley ( New York Fed President).
Caterpillar stock rose sharply when the dollar started to sell off last week and with good reason. Last quarter, for example, Caterpillar brought in a combined $6.1 billion in revenues (55% of revenues) from Asia, Europe & the Middle East and Latin America. So, any weakness in the dollar is going to help Caterpillar's top line going forward. Caterpillar may be a heavyweight company in the commodity sector, but it is definitely diversified across many sectors ( Construction, Resources, Energy, etc). This has to be an advantage, although I expect the Caterpillar stock to underperform companies with solid fundamentals in the above-named sectors if indeed we get a sustained rally in commodities. Nevertheless, here are some other growth triggers that should move the Caterpillar stock over the long term.
Caterpillar's Prospects In Construction
Firstly, one area where Caterpillar is relatively strong is U.S. construction, where the company remains the market leader. In "Construction Industries" last quarter, North America accounted for $1.664 billion out of the total $3.64 billion in revenue. Caterpillar has seen improvements in construction activity in the residential and non-residential areas and I can only see trend increasing over the next 5 to 10 years. Why? Well just look at the chart below which shows new single-family homes sold in the US since the year 2000.
As you can see from the chart, the seasonally annual adjusted rate is at about 540,000 which is more than 200,000 units below the 50-year average. The consensus is bullish in the U.S. for new residential construction as the great recession, a subdued recovery, high student debt and tepid wage growth have all meant that millennials are taking longer to get their feet on the property ladder. Furthermore, baby boomers are living longer than ever, meaning second-hand homes are coming to market much slower than normal, which again is increasing demand. Caterpillar needs this market to keep trudging along and the demographics and fundamentals seem to be favorable in my view.
Caterpillar's Prospects In Energy
Secondly, you have the energy sector which makes up Caterpillar's biggest division. Caterpillar reported a revenue loss of 29%, with revenue coming in at $4.41 billion last quarter. However, things may be changing presently in this sector for the better. Why? Well, Chevron (NYSE:CVX) and Exxon Mobil (NYSE:XOM) reported very disappointing earnings recently which will result in big operational and cap-ex cuts across the board. With crude oil at just over $30 a barrel, either eventual supply constraints or an agreement between the oil producing countries on how to cut near-term supply will enable oil prices to slowly crawl up.
One has to remember that the likes of Chevron & Exxon Mobil may be increasing production, but only because both companies brought half finished projects to completion over the last 18 months. You can be sure that if oil were to stay around these levels, these companies (which are no 1 and 2 in the US) would not have the balance sheets to embark on huge capital spends like they have done in the past. If oil does stay longer for lower, Caterpillar's cash flow presently is in a far better place than the likes of Chevron. Investing in the energy space with oil prices at $30 a barrel is much less risky now than it was when oil was at $100 a barrel, and Caterpillar's positive cash flows may make the stock a good way to indirectly invest in this sector at present.
Caterpillar Has A Solid Dividend Yield
Finally, Caterpillar has a very strong dividend of 4.66%. Despite making $2.1 billion in net income in 2015, the company was able to deliver $3.41 billion in free cash flow, which means the quarterly dividend of $0.77 is definitely safe for now. Moreover, the company normally raises its dividend in July, which means the quarterly payout should definitely hit at least $0.83 in the summer. ConocoPhillips (NYSE:COP) cut its dividend last week after promising the dividend was safe not long ago, in December. The writing though was on the wall when you went through Conoco's financials as net income and free cash flow levels were in the red all year. Caterpillar doesn't have this problem and may benefit as energy based yield investors look for solid dividends in a sector laden with risk.
Summing It Up
To sum up, the advantage Caterpillar has is that it is diversified across mining, energy and construction. Furthermore, 55% of its revenues are derived from outside the U.S., which means that more weakness in the dollar should be a positive for its international sales numbers. Mining may have formed an intermediate bottom and the Dollar looks like it will weaken some more from here. Moreover, Caterpillar still has a safe dividend compared to other large caps, especially in energy. These factors should keep the Caterpillar stock elevated.