Caterpillar: Trump's Infrastructure Spending Plan

| About: Caterpillar Inc. (CAT)

Summary

Donald Trump’s $1 Trillion spending plan could prove to be a huge boon to Caterpillar, assuming it passes through Congress.

While investors in Caterpillar probably shouldn’t be penciling-in Trump’s spending plan given broad opposition to it, we see Trump succeeding in getting an infrastructure plan similar to what Hillary Clinton wanted.

If so, this could help boost Caterpillar’s earnings by up to 7% over the next five years and would give it a one-year target price of $99 per share.

Analysis

Trump's Infrastructure Mega-Plan Faces Scrutiny

In the aftermath of the recent presidential election, stocks have rallied to new highs, with companies like Caterpillar (NYSE:CAT) surging over 10% from investors' expectation that Trump's $1 Trillion infrastructure plan would benefit sales of industrial equipment as America is seeking to rebuild its weakening infrastructure.

The need for infrastructure spending in the United States is so pressing that it was a common point of emphasis for both presidential campaigns, though they differed (among others) in magnitude: Hillary Clinton's plan was to introduce a $275 Billion infrastructure spending plan.

Regardless, members of Trump's own party - particularly its fiscal conservatives - are likely to challenge Trump's plan, which calls for an average of $100 Billion a year in infrastructure spending over a decade.

Dividend and Outlook

Even without the prospect of an outsized infrastructure investment plan, Caterpillar's stock has had a strong year, with its shares rising by 23% in the year-to-Election Day. This is despite the fact that Caterpillar's own outlook is that its revenues will dip by 17% this year while its earnings will fall by nearly 30% as demand for its products muted amidst a soft global economy.

Caterpillar's stock had mainly rallied on the back of two straight quarters of exceeding analysts' expectations and that, regardless of the outcome of the election, it could expect some kind of boost in U.S. government spending on infrastructure.

It also helps that Caterpillar has a fairly hefty dividend yield of close to 3.3%. Investors who own $10,000 worth of the blue chip's shares can expect to receive $326 in passive income each year, which is more than the average of its peers in the S&P 500 and the Dow Jones Industrial Average - and also around triple that of its peer group. Investors should note that Caterpillar has paid a dividend each year since 1925 and that its quarterly dividend payments go all the way back to 1933. In short, investors who buy Caterpillar can expect a long run of dividend payments from the company.

That America's infrastructure could use some fixing isn't really in question: the American Society of Civil Engineers have given the United States' infrastructure a grade of D+ and estimate that the country would need to invest $3.6 Trillion in the next five years in order to modernize the country's infrastructure and effect needed maintenance. The question is how much of Trump's $1 Trillion plan will survive his administration's negotiations with the incoming Congress.

As the world's leading manufacturer of industrial equipment - and likewise as an American company at a time when Trump is emphasizing putting 'America first' - Caterpillar would stand to receive an outsized benefit from Trump's infrastructure plan. To put this in perspective: Caterpillar expects $39 Billion in revenues in 2016. Were Trump to pass his plan in its entirety and just 5% of the plan's funding went to paying for new equipment made by Caterpillar, it would generate $50 Billion in incremental revenue over the next decade. This sum would allow Caterpillar to more than double its annual revenues over the next decade - a far cry from pedestrian 4.8% growth it's witnessed in the last decade.

However, as we've mentioned, Trump is likely to face an uphill battle against Congress in getting his infrastructure plan passed. This is where Hilary Clinton's plan comes in - in our view, a $275 Billion plan over five years is likely the minimum Trump's administration would be willing to accept since would allow Trump to go back to his supporters and say that he got at least as good a deal as Hillary Clinton would've gotten. In reality, this would be a $45 Billion per year comedown from Trump's original plan - but it would still represent a 33% boost to Caterpillar's revenues over the next 10 years if its related revenues reached 5% of the deal's total value.

It should also be noted that large construction projects such as this would impact the larger US economy and spur construction activity elsewhere - much in the same way that the New Deal had the effect of helping America out of the Great Depression beyond simply (vastly) improving America's infrastructure at the time. In that sense, while it's difficult to quantify at this point in time, Caterpillar could benefit from private spending that came about as a result of the Trump administration's spending program.

In fact, on an inflation-adjusted basis, both the Trump and Clinton infrastructure plans would dwarf the infrastructure spending that accompanied the New Deal - one year of Clinton or Trump's level of infrastructure spending would exceed or be close to equal the current value of the $3.3 Billion that the Public Works Administration spent on public works projects from 1935 to 1938.

Conclusion

Consequently, our view is that from 2018 onwards, Caterpillar could see at least a 7% rise in its annual revenues associated with US government spending (assuming the deal Trump gets is closer to Hillary Clinton's plan), which would help reverse the 1.9% average annual revenue contraction it has seen in the last five years. In turn, this (by itself) would provide a 7% pickup in Caterpillar's earnings per share - compared to the 5.4% annual decline in its earnings per share over the past half-decade.

Assuming its forward earnings multiples remains the same, this expected rise in earnings would imply a target price of $99 per share, which is considerably higher than the consensus one-year target of $85 per share. This represents a 5.3% upside against the current market price, for a one-year total return of 8.5%.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in CAT over the next 72 hours.

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.

Additional disclosure: Black Coral Research, Inc. is a team of writers who provide unique perspective to help inform dividend investors. This article was written by Jonathan Lara, one of our Senior Analysts. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article. Company financial data is taken from the company’s latest SEC filings unless attributed elsewhere. Black Coral Research, Inc. is not a registered investment advisor or broker/dealer. Readers are advised that the material contained herein should be used solely for informational purposes. Investing involves risk, including the loss of principal. Readers are solely responsible for their own investment decisions.