Caterpillar Dividends: Can They Be Sustained?

About: Caterpillar Inc. (CAT)
by: Alpha World

Caterpillar has an excellent track record when it comes to dividend payments.

Even at the peak of the financial crisis, the company raised its dividend.

Dividends look safe for now, as even in a conservative scenario, the company's payout ratio for 2016 will be below 1.

But the worsening outlook for oil markets means that the company may be forced to cut dividends in the medium term.

As expected, Caterpillar's (NYSE:CAT) fourth-quarter results continued to highlight the challenges the mining and construction equipment maker has been facing. All of CAT's end markets have been struggling, and this reflected in the sharp drop in the 2015 revenue. The company's guidance for 2016, not surprisingly, indicates a further drop in revenue. The question is whether in this challenging environment, Caterpillar will be able to sustain its dividend payments.

Caterpillar said late last month that it expects 2016 revenue to come in at $42 billion, which is down almost $3.5 billion from the guidance it gave in October 2015. Back in October, the outlook for commodities and oil was challenging. Things have gotten much worse since then, and in fact, it would not be surprising if the company revises its revenue forecast downwards like it did in 2015. At the start of 2015, the company had guided for $50 billion in sales for the year. But actual sales for 2015 came in around $3 billion below the initial sales outlook mainly due to worse-than-expected end markets. CAT's profit, including restructuring charges, was also well below the $4.60 per share it had forecast at the start of 2015. Actual GAAP earnings for the year were $3.50 per share.

With the company's outlook worsening since the start of this year due to a sharp drop in prices of commodities and oil, the decline in revenue could be steeper than what it is projecting. Cost-cutting measures enabled CAT to post better-than-expected earnings in 2015. Back in October, I had noted that while CAT's outlook is challenging, it is an attractive proposition for income investors. Yields on CAT at the time were just above 4%. The company is currently yielding 4.80%. With the pace of rate hike from the Federal Reserve likely to be slow, the current yield is very attractive for income investors. However, the worsening outlook does raise some doubts over whether CAT can sustain its dividends.

The company has an excellent track record when it comes to dividend payments. Indeed, the company has always given priority to shareholder distribution. And as I had noted in my last article on Caterpillar, the company does have the balance sheet strength to maintain its dividend payments.

Historically, CAT has consistently raised its dividend. Even at the peak of the financial crisis, it raised its dividend. Between 2006 and 2015, its payout ratio averaged 0.44. In 2015, the company's payout ratio was double the 10-year average of 0.44. Payout ratio though was still below 2009 levels. In 2009, CAT's payout ratio was 1.18. For 2016, the company expects earnings (including restructuring charges) at $3.50 per share, unchanged from actual earnings in 2015. If earnings are in line with expectations, then the dividends look safe. In 2015 though, its actual earnings were $1 per share lower than its forecast. Having said that, this was mainly due to additional restructuring costs. Considering that CAT is already including a $0.50 per share restructuring charge in its 2016 projections, earnings are not likely to deviate significantly from what it has forecast provided its revenue meets expectations. That seems to be the major worry.

The turmoil in oil and commodities market means that CAT's revenue for 2016 could be hit harder than what the company is projecting. If actual revenue comes in at the low end of the guidance range of $40 billion to $44 billion, earnings in this case would drop to around $3.32 per share, assuming a similar impact on bottom line. The payout ratio would still be under 1 in this case provided CAT does not raise its dividend.

Based on historical data and CAT's outlook for 2016, the dividends look safe for now. But the major concern for the company is that the downcycle could be prolonged in some of its end markets, especially oil. This morning, the International Energy Agency (NASDAQ:IEA) said that the global oil glut is larger than previously thought. Goldman Sachs noted that prices could drop to $20 per barrel. In such a scenario, CAT's dividend will come under threat. In earlier articles, I had stressed that CAT was a buy mainly because of income. While I don't see dividend payments under threat in the near term, the company may be forced to cut dividends if the outlook for its end markets does not improve in the medium term.

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.