When it comes to the least sexiest stocks in the Dow Jones Industrial Average, it is difficult to find something more boring that Caterpillar Inc. (NYSE:CAT). That doesn’t necessarily mean it’s a bad thing. The best stocks can sometimes involve the most boring of businesses. When it comes to Caterpillar stock, however, the underlying business has generated an awful lot of concerns for this investor.
Caterpillar is, quite simply, a manufacturer of industrial machinery. It is actually “the world’s leading manufacturer of construction and mining equipment, diesel and natural gas engines, industrial gas turbines and diesel-electric locomotives” according to the company itself.
CAT is obviously a well-entrenched brand name, with 48 dealers located in the U.S. and almost three times that number across 182 other countries, and almost 1,300 dealer rental sites. It has a massive footprint and great reputation.
The problem with CAT and therefore Caterpillar stock is something that I’ve always been concerned about when it comes to industrial goods companies — economics. Caterpillar stock is extremely sensitive to economic conditions on both regional and global scales. It’s essentially a cyclical business.
That’s just part of the bad news. The other part of the bad news is that a large part of its business involves selling mining equipment, which means the stuff that is mined are commodities, which are themselves subject to market forces … and commodities have been crushed over the past several years, tempering demand.
It gets worse. Caterpillar stock is also subject to interest rates, which affect economic growth, which is what drives demands for industrial goods. We’ve been sitting on historically low interest rates for years, yet CAT stock has not been responding terribly well. What happens when rates rise?
Caterpillar last saw a revenue increase year over year in FY12, to $65.9 billion from $60.14 billion. Alas, since then, revenues fell to $47 billion in FY15 and are only at around $10 billion through the first six months of this year. The second-quarter conference call was lousy, where CAT said it saw no obvious recovery signs for mining — not surprising given the state of the commodities markets.
Cash flow is deteriorating — $10.19 billion in operating cash flow in FY13 fell to $6.67 billion in FY15. Free cash flow declined from $5.8 billion to just $3.4 billion. The dividend payout ratio rose from 20% to 50%.
I’m not done yet. The CEO just bailed. He did this just a week before the earnings announcement for Q3. Think about the timing. He could have left at any time, but this just portends bad news with no obvious signs of a turnaround.
The good news is that its $25 billion debt burden only costs it 2% per year. That’s about the only good news I can find.
This leads back to the same problem I have had with many of these “safe” stocks. Investors hold a $51 billion company that has negative earnings growth — giving it a 25 times valuation — which makes absolutely zero sense.
I fear that many income and retired investors are in CAT stock for the 3.5% yield, but the prospect that CAT stock is worth far less means a 3.5% cushion is nothing in the face of a major correction.
Once again, I have to suggest that holders of Caterpillar stock sell it unless it triggers a massive tax bill. If you want a far safer dividend, then just get into a basket of preferred stocks.
Lawrence Meyers is the CEO of PDL Capital, and manager of the forthcoming Liberty Portfolio stock newsletter. As of this writing, he has no position in any stock mentioned. He has 22 years’ experience in the stock market, and has written more than 1,600 articles on investing. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.
