Is Caterpillar Dividend Safe?

Leading construction equipment manufacturer Caterpillar Inc. (NYSE:CAT), which ranks #78 on the Fortune 500 list and #102 on the Magazine’s World’s Most Admired Companies List, is known for raising its dividend payments for 30 consecutive years.

Its long streak of incremental dividend payments makes it a constituent of the S&P 500 Dividend Aristocrats Index. Dividend Aristocrats are companies with at least 25 consecutive years of dividend growth.

After so many increases, though, can investors rely on the dividend to be safe and sustainable?

Why Dividend Investors Flock To Caterpillar

Caterpillar, which started as a steam tractor manufacturer in 1925, supplies heavy machinery for construction, mining, and other industries. Over the years, it has evolved through acquisitions and strategic expansion to serve market demand in 191 countries.

The company is renowned for its tenured dividend-paying history. It has consistently paid quarterly dividends since 1933 and these dividend payouts have grown at a compounded annual growth rate of 7.4% over the past 3 years and 8.7% over the past 5 years.

Caterpillar’s forward annual dividend of $5.20 per share yields 1.5%. While this is not very high, it’s noteworthy for a cyclical company. As an aside, the four-year average yield is 2.2%, suggesting Caterpillar’s price is elevated relative to its yield based on historic norms.

Caterpillar’s payout ratio is 24.1%, indicating that the company is relatively conservative in sharing its earnings with shareholders, so it can reasonably maintain its dividend payments.

Moreover, its robust cash flows should help fund future dividend obligations. In the fiscal year 2023, the company’s operating cash flow stood at $12.9 billion while free cash flow reached a record $10 billion, surpassing the company’s target by more than $2 billion.

Free cash flow for the last five years stood at over $30 billion, demonstrating its steady cash generation capabilities. Management has also raised the FCF target range to between $5 billion and $10 billion from the $4 billion to $8 billion range projected earlier.

Last year, Caterpillar paid shareholders a record $7.5 billion through dividends and share repurchases. Furthermore, it increased its quarterly payout by 8% in 2023 and expects to increase its dividend by at least high single digit percentages this year as well.

Is Caterpillar Growing?

Last year was the best one in Caterpillar’s 98-year history. The company registered record full-year sales, revenues, and adjusted profit per share.

In FY 2023, total sales increased by 13% year-over-year to $67.06 billion, primarily due to favorable pricing and robust sales volume. The company’s adjusted operating profit margin also increased significantly from 15.4% in the prior fiscal year to 20.5%, surpassing management’s guidance range by 80 basis points.

Adjusted profit per share grew by 53.3% from the year-ago level of $21.21 per share. Liquidity remained steady, with a cash balance of $7 billion at the end of 2023. Healthy demand across its businesses led to a backlog of $27.50 billion, which is somewhat elevated versus historical levels.

In addition, the company’s sales increased by 3% year over year to $17.1 billion for the fiscal fourth quarter ended December 2023. Moreover, adjusted profit per share was $5.23 per share, compared to $3.86 per share in the year-ago quarter.

Caterpillar expects strong demand for products and services across its end markets, and forecasts sales similar to 2023 levels this year. Indeed, the company is well on track to grow profitably long-term.

Industry Cyclicality Poses Risks

The construction equipment industry’s cyclicality makes Caterpillar highly susceptible to macroeconomic fluctuations. Downturns reduce capital expenditures and mute business opportunities for the company. Demand across its businesses tends to fall significantly amid reduced investments, elevated interest rates, and tighter credit conditions.

With all that said, the company succeeded in handling cost pressures during lockdowns a few years ago through strategic pricing initiatives.

Looking to the future, improving demand from infrastructure projects and investments in clean energy initiatives are set to drive prospects.

However, elevated interest rates might not bode well for the company. While the Fed maintained its projections for three rate cuts this year in its last meeting, Chairman Jerome Powell and his investment committee left rates elevated and unchanged.

If persistently high rates flow start to affect the broader economy in a more pronounced way, Caterpillar is likely to suffer more than most.

Is Caterpillar Dividend Safe?

Caterpillar dividend appears to be safe because it has a payout ratio of just 24.8% and an abundance of free cash flows. In addition, the Board of Directors has approved dividend increases for 30 years consecutively, thereby showing a loyalty to shareholders.

As a dividend aristocrat, Caterpillar is a trusted income source for shareholders and the low payout ratio suggests the annualized dividend of $5.20 per share, paid out quarterly, is at no risk of interruption anytime soon.

Is Caterpillar Stock a Buy Now?

In addition to its popularity as a consistent dividend-payer, Caterpillar’s stock has shown solid momentum lately, gaining more than 60% over the past year and, remarkably, over 20% year to date. 

Despite delivering impressive returns, the stock is trading at a non-GAAP price-to-earnings (P/E) ratio of 16.91, more than 10% lower than its sector median and about a 6% discount to the 5-year average. However, it is also trading at 2.66x forward sales, which is over 75% higher than the sector median.

Trading at a forward non-GAAP price-earnings-to-growth (PEG) of 2.09x, the stock looks expensive, even when considering the expected growth over the next 3-5 years.

As a result, despite being a reliable dividend payer, it seems wise now to wait for a better entry point in the stock.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.