Weakness In Heavy Equipment Manufacturers Creates Dividend Growth Opportunities

Includes: CAT, CMI, DE, ETN, ITW, PCAR
by: Dividends For The Long Haul

Around 5:30 PM, on October 9th, Cummins (NYSE:CMI) released lowered FY12 revenue guidance from $18 billion down to approximately $17 billion. The company cited weak demand as a result of weak economic data adding uncertainty to the direction of the markets, and causing companies to delay capital expenditures. Cummins said that the markets most affected by the soft demand were the North American Heavy Truck market and the International Power Generation Markets. Cummins also announced it is taking actions to reduce costs, such as planned workweek reductions and a workforce reduction of 1000-1500 by year's end, while continuing to maintain investments in growth programs. The company hopes that by taking these actions now it will position itself as a stronger company, more prepared to capitalize on the inevitable rebound of the markets.

The negative guidance issued by Cummins comes just a few of weeks after Caterpillar (NYSE:CAT) management also issued lower guidance for this year and 2015 on soft demand. After issuing this reduced revenue guidance, shares of Cummins were off nearly 5% in after hours trading. Other equipment stocks were suffering as well, with CAT down 1.8% and Deere (NYSE:DE) down roughly 1%. With this latest negative guidance, heavy equipment manufacturers are offering dividend growth investors with buying opportunities for long term gains.


Cummins is a major equipment manufacturer who designs, develops, and sells engines and related peripherals like fuel systems, filtration and emissions controls. Cummins is the world's largest producer of diesel engine technology, and in 2011 had revenue of $18B. CMI issued lowered revenue guidance for FY12 expecting revenue for the full year to come in at $17B. Since the 16th of September, shares have declined from $102 to the current after hours trading price of $86.28.

Based upon the current share price, shares of Cummins have a TTM P/E ratio below 9 versus a five year average P/E ratio of 16.0. CMI has grown EPS by 31% over the past 12 months and anticipates EPS growth of 12.75% over the next five years. With long term debt to equity of approximately 10%, CMI, sports a very low debt load. The current $2.00 annual dividend works out to a 2.3% yield, on a payout ratio of below 16% of earnings. Cummins has grown its dividend at nearly a 32% rate over the past 5 years, and appears to have significant room to continue to grow its dividend.

In the wake of this negative guidance issuance, shares of Cummins have been crushed. While the company has come forward and announced that economic challenges will affect earnings CMI is a well-run company, and has been punished well beyond what is reasonable. At the current share price level, Cummins is one of the best buy stocks on the market. I have previously described CMI as a growth stock and a dividend stock rolled into one. Now trading at a significant discount, CMI is one of the best buys for DGI investors. Investors can now buy into a stock with payout ratio below 20%, that has averaged dividend growth of greater than 30% over the past five years at a terrific value. CMI should be able to increase its dividend by double digit percentages for years to come, and the growth in earnings should support an increasing share price for years to come. DGI investors should take a close look at CMI.


Caterpillar designs, manufactures, and sells machinery, equipment, and engines to customers around the world through its dealer network. The company is the world's largest provider of construction and mining equipment with annual revenue of $60B+. In late September CAT announced lowered 2015 guidance, as well as providing guidance that 2012 revenue may come in up to $2B below previous estimates. In response to the Cummins guidance, shares of Caterpillar have fallen nearly 2% during after-hours training.

Shares of Caterpillar are trading near $83 which gives the shares a TTM P/E ratio of roughly 9, which is well below the five year average of 17.3. The company expects to see challenges in the global economy and the mining sector in particular, which will affect earnings in the years ahead. Even with the challenges ahead for these sectors, EPS is expected to grow by 14% annually over the next 5 years. CAT is paying out just 20% of earnings, and has already announced that the dividend will not be cut during a downturn. The downside with CAT is that the company carries a lot of debt. CAT has grown its dividend by nearly 8% each of the past 5 years, with the most recent increase being 13%. With a history of 19 consecutive annual increases, CAT will look to continue this streak.

While negative guidance from Cummins, as well as its own lowered guidance has hurt the share price, CAT has come out prepared for the worst. By reducing guidance three years in advance, the company has set itself up to beat on earnings and increase guidance in years ahead. The company has committed to paying and increasing the dividend, and patient dividend growth investors who get involved now may benefit for years to come. With low payout ratio and double digit earnings growth, CAT should be able to increase the dividend at a rate near its five year average while facing the economic headwinds. As the economy recovers, shares of CAT should be positioned well to recover and experience significant capital appreciation, as the equipment giant begins to generate more revenue.


Deere manufactures agricultural, construction, and consumer equipment including everything from tractors, to backhoes, to riding mowers, and everything in between. The company sells its products through its branded retail dealer network, as well as through additional major retailers.

Deere was trading at $81.73 per share as of closing October 9, 2012, but fell another 1% in the wake of the lowered Cummins guidance. Shares currently sport a TTM P/E ratio below 10.7, well below its 5-year average P/E of 15.96 and the industry average of 20. The company has grown EPS by 23.5% over the past 12 months, and expects to continue growing earnings by 12.3% over the next 5 years. Much like with CAT, the primary concern with DE centers on the company's debt, with long-term debt/equity of more than 200%.

Soft demand will affect DE, just as it will other equipment manufacturers but DE has the strength to reward long term investors with the patience to ride out the soft demand and weak market conditions. Deere and Co. pays an annual dividend of $1.84, which equates to an annual yield of 2.27%. DE has raised its dividend for 9 straight years with the most recent increase being just over 12%. With a low payout ratio of 23%, DE should be able to maintain growth near the 5-year dividend growth rate of 16%. While the company does carry significant debt, with the low payout ratio, 12% expected earnings growth, and low current valuation DE appears to be an undervalued stock offering the potential for capital appreciation and dividend growth. I would expect for DE to continue t raise its dividend in the neighborhood of 10% in the coming years.


September and Early October have not been kind to heavy equipment manufacturers. With Caterpillar and Cummins both issuing lowered guidance for the year, equipment stocks have been punished. With strong underlying business fundamentals, many of these equipment manufacturers appear to be poised to return significant value to shareholders through both capital appreciation and increasing dividends. In my opinion Cummins appears to be the best of the bunch, but all three offer significant dividend growth opportunities and trade at favorable valuations.

While the three stocks discussed above all appear well positioned to see significant share price increases and growth in their dividend payments, other equipment stocks,like Eaton (NYSE:ETN), PACCAR (NASDAQ:PCAR), and Illinois Tool Works (NYSE:ITW), may also be worth a look.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in CMI 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.