Caterpillar Cuts 2016 Guidance, But Dividend Secure For Now

| About: Caterpillar Inc. (CAT)


Caterpillar reduced its guidance for 2016.

The downward revision was expected considering the weak performance in first-quarter results.

There are signs of some improvements in some of Caterpillar’s end markets.

Dividends look safe for now.

Caterpillar (NYSE:CAT) reported its first-quarter results before market open on Friday. The company had already provided guidance for Q1 a few weeks ago so the results did not throw any surprises. However, CAT did reduce its 2016 guidance.

Q1 Results, A Quick Glance

Caterpillar's first-quarter results once again highlighted the challenges the mining and construction equipment maker has been facing due to the weakness in its end markets. First-quarter revenue was $9.5 billion, down significantly from the $12.7 billion reported in the first quarter of 2015. Excluding restructuring costs, CAT's earnings for the quarter were $0.67 per share, down from $2.07 per share reported in the first quarter of 2015. CAT had already prepared the market for the low earnings a few weeks ago.

Outlook Slashed

Caterpillar lowered its sales and earnings outlook for 2016. I had argued in an earlier article that CAT will at some point reduce its guidance because of the weak performance in the first quarter. As expected, the company lowered the mid-point of its revenue guidance. CAT had earlier forecast revenue to be between $40 billion and $44 billion. The company has narrowed the range to $40 billion to $42 billion.

CAT lowered its earnings guidance from $3.50 per share (GAAP) to $3 per share. Excluding restructuring costs, earnings for 2016 are expected at $3.70 per share, 30 cents below the previous forecast.

As I had discussed in my article exactly a month ago, meeting the initial guidance would have been an uphill task for CAT, considering the state of most of its end markets. In fact, CAT's earlier guidance implied that it expected market conditions to improve significantly in the second half of the year. Now some of CAT's end markets are indeed showing signs of improvement. However, its effect will not be felt in the second half.

State of End Markets

Caterpillar's end markets are still weak but the outlook is certainly better than what it was at the start of this year. Indeed, this was something even Caterpillar noted in its earnings release on Friday. The slowdown in China's economy and fears of a hard landing have forced policymakers in the world's second-largest economy to announce stimulus measures. These measures are starting to have an impact as seen by some recent economic data. Data from China's housing market is especially positive for Caterpillar. In the month of March, new home prices rose in 62 of China's 70 major cities. Some of the tier 3 and 4 cities registered the first month-over-month increase in price since the end of the first quarter of 2014. New home construction has also picked up.

The outlook for oil has also improved. Prices got a boost recently because of supply disruptions in Kuwait. Although major producers failed to reach a deal on freezing production at a meeting in Doha last weekend, fundamentals are certainly improving. The International Energy Agency (IEA) said recently that the oil market could rebalance by next year as non-OPEC production registers its biggest drop in a generation.

The improving outlook for the end markets will not have an immediate impact on CAT's financials. This is why the company had to lower its expectations for 2016. However, it does mean that the worst is possibly over for CAT. Indeed, this might explain the muted reaction to CAT's downward revision to its outlook. On Friday, the stock was marginally higher in late trading.

Dividends Remain Safe

Finally, coming to CAT's dividends, as I have noted before, they remain safe for now. CAT's track record when it comes to dividend payments has been stellar. As I noted in an article earlier, CAT raised its dividend even at the peak of the financial crisis. Based on CAT's lowered guidance for earnings for 2016, the company will now have a payout ratio of just 1.02. While this is well above the 10-year average of 0.44, it is below the payout ratio of 1.18 in 2009. Dividends would be under threat only if the weakness in CAT's end markets persisted. However, as I discussed above, the outlook in many of these markets is improving. Therefore, dividends look sustainable for now.

Disclosure: I am/we are long CAT.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.