Caterpillar: Are Dividends Safe?

| About: Caterpillar Inc. (CAT)

Summary

Caterpillar lowered its guidance once again.

End markets remain weak.

But dividends still not under any threat.

Caterpillar (NYSE:CAT) reported its second-quarter financial results on Tuesday, posting better-than-expected results. The company though lowered its earnings guidance and also narrowed its revenue guidance range. Despite the gloomy outlook, Caterpillar shares rallied on Tuesday. The cautious outlook though does not threaten dividends and that may be the reason why CAT shares are hovering near 52-week highs.

Q2 Results Beat

For the second quarter, Caterpillar reported profit and sales that beat expectations. I must add though that the bar was quite low so one should not get too excited about the earnings and revenue beat.

Caterpillar reported second-quarter earnings of $1.09 per share. According to Seeking Alpha, the consensus forecast was $0.96 per share. The 13 cent beat was significant but as I noted, the bar had been set quite low for the second quarter. Caterpillar's revenue was $10.34 billion, down 16.1% on a year-over-year basis. The significant decline in revenue highlights the ongoing challenges faced by CAT in nearly all of its end markets. Revenue though beat consensus forecast by $280 million.

Gloomy Outlook

In recent articles on Caterpillar, I had noted that some of the company's end markets were showing signs of improvement. However, that conclusion might have been premature. Indeed, the recovery in oil prices has been derailed due to concerns over a glut in the downstream section of the market. In any case, the recovery in the oil market was in the nascent stage and its impact, if any, would not have been felt by CAT at least until next year.

It was not surprising then to see Caterpillar issue a rather gloomy outlook for the second half of this year. In fact, I had expected a downward revision to CAT's full-year guidance ever since the company released its first-quarter financial results. The company has now reduced its 2016 guidance twice.

The first downward revision came in April. At the time, the company lowered its GAAP earnings guidance to $3.70 per share from $4 per share, non-GAAP earnings guidance to $3 per share from $3.50 per share and narrowed its revenue guidance from $40-$44 billion to $40-$42 billion. On Tuesday, Caterpillar lowered its guidance further. Non-GAAP earnings for the full year are now expected to come in at $2.75 per share, GAAP earnings to come in at $3.55 per share and revenue to come in between $40 billion and $40.5 billion. The non-GAAP earnings are now more in-line with what I had anticipated following the weak Q1 results.

Chairman and CEO Doug Oberhelman said that he does not expect an upturn to happen this year. In fact, given the state of CAT's end markets, expecting an upturn in 2017 would be optimistic. Remember that apart struggling end markets, CAT also faces Brexit uncertainty. I will discuss this in detail in a separate article, however, I would like note here that CAT has sizable operations in Britain. The company uses its British base to export to markets in the European Union, taking advantage of the common market. Brexit threatens that. It is unlikely that the EU will agree to free movement of goods without free movement of people. At best, Britain can expect to have a deal like Norway. The Scandinavian country has access to the common market without being a member of the EU but it also allows free movement of people from EU countries. Given that most of the Brexit rhetoric was based around immigration, it is unlikely that Britain will accept such a deal. In that case, Britain will face tariffs, which will have implications for companies like CAT using the island nation as a base.

Dividends Not Under Threat

Despite the downward revision, CAT's dividends remain safe. In fact, even if there are further downward revisions, CAT's dividend payments are not likely to come under threat. Based on the latest earnings guidance of $3.55 per share (GAAP), CAT has a payout ratio of under 1. The payout ratio is above 1, 1.12 to be precise. While this is wells is well above CAT's 10-year average of 0.44, it is still below the 1.18 CAT paid in 2009. The 1.18 payout ratio was based on GAAP earnings. If GAAP earnings are taken into account then we are still well below 2009 levels. Given CAT's strong balance sheet, I do not see any threat to dividend payments. Dividends will only come under threat if the downturn continues for a prolonged period. That seems unlikely.

In fact CAT's strong track record when it comes to dividends and attractive yields are the main reasons why the stock is now close to 52-week high. When 30% of the world's government debt is trading at negative nominal yields, a yield of 3.72% is very attractive for income investors. I believe that CAT might have topped out after its recent runs but most investors in CAT are in for dividends. They look safe 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.