On June 10th last year, Caterpillar (NYSE:CAT) had hiked its dividend by 10%, which did come as a surprise considering the state of many of CAT's end markets. Ahead of the CAT's Board's meeting this year, there were expectations of a slight increase. The Board though voted to maintain the dividend. I believe that was the right decision.
As I have noted in earlier articles, Caterpillar has an excellent track record when it comes to dividend payments. The company has followed a progressive dividend policy and even hiked its dividend during the financial crisis. Since 2011, CAT has hiked its dividend four times; the last time in June 2015.
This year, at best, CAT was expected to announce 3-4% dividend hike. The company instead chose to maintain its dividend. Remember that CAT is still yielding more than 4%. Considering the yield on Treasuries, this is still a very attractive yield.
End Markets Improving, But Short-to Medium-Term Outlook Still Challenging
In April, Caterpillar lowered its financial guidance for the full year. This, as I had noted in an article in March, was expected after the company gave projections for the first quarter that were well below consensus forecast. CAT has lowered its sales and earnings outlook for 2016. The company now expects GAAP earnings of $3 per share for 2016. On a non-GAAP basis, earnings are expected to come in at $3.70 per share.
The good news for CAT is improvement in some of its end markets. There has been a significant recovery in oil prices from February lows, driven mainly by supply outages. The supply outages, combined with robust demand especially from India, have meant the oil market's fundamentals are improving sooner-than-anticipated.
In its latest monthly report, the Organization for Petroleum Exporting Countries (OPEC) kept forecasts for global oil supply and demand unchanged. OPEC expects global oil demand to increase by 1.2 million barrels per day, led by India. Non-OPEC production, meanwhile, is expected to fall by 740,000 barrels per day.
China's housing market is also showing signs of recovery. In recent months, property prices and sales have increased. This has been driven partly by looser lending policies. According to data from the National Bureau of Statistics, between January and April, China's housing sales rose 61.4%. Construction starts in the first four months rose 21.4%.
While improvement in some of the end markets is encouraging, CAT is not completely out of the woods yet. Indeed, the company is likely to continue to face challenges in 2017. Although oil prices have recovered, capex spending is not likely to recover until we see a sustained period of high prices. While China's housing market is showing signs of improvement, there are also concerns about the high levels of debt. The rebound in commodities such as iron ore at the start of this year was driven more by speculation than fundamentals. Indeed, the outlook for commodities remains mostly bearish. Given the macro environment, Caterpillar has done the right thing by not hiking its dividend payments.
Dividends Not Under Threat
Following the downward revision to its earnings, Caterpillar now has a payout ratio of 1.02. This is above the 10-year average of 0.44. As I noted earlier, CAT has done the right thing by not hiking its dividend this time, given that the company already has a high payout ratio and the short-to medium-term business outlook remains challenging. Having said that, I continue to believe that CAT's dividends are not under threat. While the payout ratio of 1.02 is significantly higher than the 10-year average, it is still below the payout ratio of 1.18 in 2009. And remember in 2009, the financial crisis had just begun. In 2016, the worst is possibly over for CAT. I believe that long-term investors should hold on to CAT for regular dividends, which remain safe.
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.