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Before I start the dividend stock analysis I want to mention to new readers that there is another article that you may want to read first. The other article better explains what I’m looking for in a company from a dividend growth perspective and why I analyze specific company components and ratios. The other article is meant more as an educational tool so that readers can better understand my dividend stock analyses. This dividend stock analysis will look at the company to identify if it is a good dividend growth candidate to invest in.

Caterpillar Dividend Stock Analysis

Company Description

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From Google Finance:

“Caterpillar Inc. (Caterpillar) is a manufacturer of construction and mining equipment, diesel and natural gas engines, industrial gas turbines and diesel-electric locomotives. It operates in two segments: Machinery and Power Systems, and Financial Products. Machinery and Power Systems represents a total of Construction Industries, Resource Industries, Power Systems and All Other segments and related corporate items and eliminations. Financial Products includes the Company’s Financial Products Segment. This category includes Cat Financial and Caterpillar Insurance Holdings Inc. Effective March 1, 2012, it announced that Caterpillar Japan Ltd. acquired Caterpillar Tohoku Ltd. In August 2012, Platinum Equity, LLC. acquired a majority interest in Caterpillar Logistics Services. Caterpillar will retain a 35% interest in the business. In October 2012, Finning International Inc acquired from Caterpillar of the former Bucyrus distribution and support business in its dealership territory.”

10 Year Stock Chart

The 10 year annual average return is 11.6%. If we include the dividend payments over the past 10 fiscal years (Total dividends paid of $13.54) then the total average annual return would be 13.3% with the average annual return from dividends representing 1.7%.

Caterpillar 10 Year Stock Chart June 16, 2013

When I look at the chart, I’m not that surprised. I can see that Caterpillar was hit quite hard in 2008 and 2009 due to the global financial crisis, but it has recovered quite well since then.

Revenue and Earnings

Caterpillar has a fairly good revenue chart with the exception of 2009 and maybe 2010. In 2009 revenue and net income dropped significantly, but the company was able to bounce back by 2011.

Caperpillar Revenue & Net Income Chart

The revenue per share and EPS chart shows the same trend, which is to be expected.

Caterpillar Revenue Per Share and EPS Chart

It took two years for Caterpillar to recover from the global financial crisis, which is a blemish on an otherwise impressive history. While 2009 was particularly bad, they did not lose money which is a small consolation prize.

When the 10 year average annual increases for Caterpillar are examined it shows some impressive growth.

Caterpillar 10 Yr Revenue Increas Table

The 10 year growth rates are all well above the 8% I typically look for.

Dividends

Caterpillar has increased their dividend for 19 consecutive years in a row with their most recent increase occurring with the dividend declared earlier this month (June 2013) when they increased the quarterly dividend by 15.4% from $0.52 to $0.60.

Caterpillar Dividends Chart

The chart shows a steadily increasing dividend, which is good, but some of the years show fairly small dividend increases.

Dividend Growth

Caterpillar has good, but not great average annual dividend growth rates.

Caterpillar DGRs Table

I like to see rates above 8%, but the 3 year average annual growth rate comes in almost 3% below this. With the most recent dividend increase of 15.4% it looks like dividend growth may be improving.

Dividend Sustainability

The 10 year average annual dividend growth has been significantly lower than EPS growth which is a great sign as it points to a very sustainable dividend.

Caterpillar EPS vs DGR

Earnings have been higher than dividend growth so it is not surprising to see that the payout ratio has been coming down recently.

Caterpillar Payout Ratios

It looks like Caterpillar has been targeting a payout ratio of 20-30%, but because of the troubling times in 2009 it spiked up above 100%. Because of this spike up the 5 and 10 year payout ratio averages look inflated.

Estimated Future Dividend Growth

Analysts expect annual EPS growth to be an impressive 14.0% for the next 5 years. Accepting this EPS growth rate and using various payout ratios we can guess future dividend growth rates.

Caterpillar Future Dividend Growth

The 5 and 10 year average payout ratios are inflated because of 2009, so I think a more reasonable target would be a payout ratio of 20-30%. This would result in annual dividend growth ranging from 10.7% to 20.1%. The most recent dividend increase was 15.4%, so my guess is that dividend growth will be in the middle of this range.

Competitive Advantage & Return on Equity (ROE)

I would consider Caterpillar to have a wide moat over the competition, due to its strong brand. The ROE chart is erratic, but the majority of time it is well above 20% which is good.

Caterpillar ROE Chart

The industry average for farm and construction machinery is 37.3%, which Caterpillar is currently below. That said, when I look at the more direct competitors (CNH Global NV, Terex Corporation, and Komatsu Ltd) Caterpillar’s ROE is well above them. Caterpillar is below Deere & Company, but Deere & Company caters more towards farm equipment, where Caterpillar is more industrial equipment, so I wasn’t sure how great the comparison would be. I kept the Deere & Company comparison, mostly because Yahoo Finance and Morningstar show it as a competitor and I am not overly familiar with the industry.

Caterpillar Industry ROE Table

Caterpillar has a very strong and well known brand, so overall I would say it has a strong competitive advantage, even if the ROE is showing mixed results.

Debt & Liquidity

I want to invest in companies that are fiscally responsible, so it is important to look at debt levels and see that they are at reasonable levels. The debt to equity ratio is above the 1.0 that I like to see, but this is common in the industry and you can see that Caterpillar has been operating above 1.0 for the past 10 years. While the debt to equity ratio is above 1.0 it is still the lowest in the past decade, and by industry standards it is at acceptable levels. The current and quick ratios are fine.

Caterpillar Debt Table

Fitch rates Caterpillar’s debt at an “A” level, which is a good sign. Overall I’m not worried about debt or liquidity.

Shares Outstanding

Shares outstanding decreased from 2003 to 2008, but since then they have been growing. I’d like to see shares outstanding start to decrease.

Caterpillar Shares Outstanding

Valuation

I use the low price averages for 6 main ratios to determine a fair price: Yield, Discount/Premium of the low price compared to the Graham Price, P/E, P/B, P/Sales and P/Cash flow. I like to look at both EPS and EPS from continuing operations so it ends up being a total of 8 ratios as the Graham Price an P/E both use EPS. You can read more about my valuation method here.

I get the following for Caterpillar.

Caterpillar Valuation Table

* The discount or premium to Graham Price hasn’t been calculated in the normal fashion. For the details read this article.

I use the averages from the previous table to determine my target price. Using these averages creates a lot of different target prices, so I back-test this strategy over the past 10 years. I identify which of the 8 valuation techniques would have given me a chance to buy the stock in two to three fiscal years in the past 10 fiscal years. It’s not always possible to test my strategy back 10 years, due to limited financial information, but I do my best. The results are highlighted below.

Caterpillar Target Prices Table

The average of the highlighted amount gives me a target price of $67. That would result in a dividend yield of 3.58%. I think this is a reasonable target, so I kept the realistic target price the same at $67.

Morningstar currently rates Caterpillar as a 3 star stock as it is currently priced around their estimated fair value of $98. For Morningstar to rate Caterpillar as a 5 star undervalued stock the price would have to fall below their “consider buy price” of $58.80. My target price is above theirs, but I still think my target price is conservative as the last chance you would’ve had to buy Caterpillar at $67 came in 2010.

Trend Analysis

I also like to look at INO`s Free Trend Analysis prior to investing to see if I should hold off or not. Sometimes it is nice to see if the stock is trending down or up before buying it. For June 16, 2013 INO is showing a downtrend for Caterpillar:

Caterpillar INO Trend Analysis June 16, 2013

To see the most recent trend analysis for Caterpillar click here. INO also has a list of the top 50 trending stocks and free trading seminars and videos.

Other Investment Options in the Same Industry

I thought it would be good to compare Caterpillar to some other companies in the same industry that also have a strong dividend growth history, but a lot of the direct competitors don’t have a very good dividend history. CNH Global NV paid out a special dividend in 2012 of $10, but the 3 previous they didn’t pay out any dividends. Komatsu Ltd. looks like it had a dividend cut in 2009 and Terex Corporation doesn’t pay out a dividend.

Instead I had a look at Yahoo Finance and the May 31, 2013 US Dividends Champions and looked at some companies in the Industrial Equipment, and Farm Equipment industry that had strong dividend fundamentals. I updated price and dividend data and ended up with Deere & Company and Parker-Hannifin Corporation.

Caterpillar Competitors Table 1

Deere & Company and Parker-Hannifin have similar dividend growth rates, but I prefer Deere & Company as it has a higher yield, lower payout ratio and higher annual estimated growth. I’d expect larger future dividend growth from Deere & Company. That said, it’s hard to compete with 57 consecutive years of dividend increases. Parker-Hannifin is tied with 5 other companies for the 3rd longest dividend streak for US companies.

Parker-Hannifin and Deere & Company are compelling dividend growth options, but Caterpillar’s yield is the highest and I’d expect dividend growth to be roughly the same as Deere & Company, and higher than Parker-Hannifin’s. When I look at them from a valuation perspective, none of them look particularly undervalued.

Caterpillar Competitors Table 2

Caterpillar is currently priced 14% below Morningstar’s fair value, and the others all look to be trading very close to fair value. When the average yield is compared to the current yield I can see that all three companies are trading within 10% of their 5 year average yield which suggests they are fair value priced right now. I like to invest in undervalued stocks, so I’ll be hoping for a price drop before I consider investing in any of these.

Conclusion:

Caterpillar has a strong well known brand that has translated into a competitive advantage. Like a lot of companies during the global financial crisis it went through tough times in 2009, but they still managed to increase their dividend and they have more than recovered. Because of the hard times in 2009 past dividend growth suffered, but I expect a strong future dividend growth, somewhere around 15% annually. If Caterpillar were to drop below my target price of $67 I would consider investing.

Disclaimer

I do not own any of the shares mentioned. You can see my portfolio here. I am a blogger and not a financial expert. These writings are my own opinions and should not be considered financial advice. Always perform your own due diligence before purchasing a stock. I mention target prices in this article, but this is not a recommendation to buy this stock, it is just a target price I use for my own personal investing that I have chosen to share.

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One Comment

  1. Caterpillar performance has been effected due to the fall in average prices of coal and copper since the start of 2011, which caused coal and copper companies to reduce investment in future projects, lowering demand for Caterpillar’s mining machinery according to http://goo.gl/AhVnWq analysis.

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