CAT - Caterpillar Operates In An Expanding TAM

Summary

• Caterpillar is a true dividend aristocrat, as the company has increased its dividend per share for many years.
• Despite headwinds such as supply chain constraints and inflationary pressures, Caterpillar's results were impressive, total revenue for fiscal year 2022 increased by 16.5% and adjusted EPS increased by 28%.
• Sales increased strongly across all business segments, and the company is operating in an expanding total addressable market as the energy transition gains traction.
• Caterpillar returned $6.7 billion to shareholders from its $5.8 billion in free cash flow in 2022 through dividends and share repurchases.
• The expanding total addressable market, strong growth figures, consistent dividend increases, and favorable stock valuation make the stock a good buy.

Introduction

Investors who purchased Caterpillar ( CAT ) stock 10 years ago would have earned a good total return of 13.7% per year, which is higher than the return of the S&P500. The stock's price volatility is one disadvantage, but long-term investors should be fine with it.

Caterpillar's revenue fell during the Corona crisis but rebounded the following year. Revenue, operating profit, and profit per share all improved significantly in the third quarter, and with an order backlog of $9.4 billion up from the same quarter last year, the company is well-positioned for future growth.

The expanding total addressable market, strong growth figures, consistent dividend increases, and favorable stock valuation make the stock a good buy.

Strong Fourth Quarter Earnings And Expanding TAM

Caterpillar released its fourth-quarter earnings report today. The top line was strong, with revenue increasing 20% to $16.6 billion, but the bottom line was mixed, with GAAP profit per share decreasing 29% year on year to $2.79 per share. The lower GAAP profit was due to goodwill impairment (lower locomotive sales forecast), mark-to-market changes to pension liabilities, and Rail division restructuring costs (write downs of inventory value). GAAP profit per share increased by 43%, owing primarily to increased favorable price realization and sales volume. Caterpillar continues to face headwinds such as supply chain constraints and inflationary pressures, which have been offset by increased pricing.

Sales increased significantly across all business segments in the fourth quarter. Sales in the Construction Industry segment increased by 19% over the same period last year. This business segment contributes most to total revenue (44% of total ME&T revenue). Revenue from Resource Industries was $2.7 billion, a 26% increase over the same quarter last year. Revenue from Energy and Transportation increased 19% to $5.7 billion. Furthermore, Caterpillar's backlog has grown by $7.4 billion since the same quarter last year. These strong results indicate the resilience of the business segments.

Looking at the 2022 results, we see a nice year-on-year growth. Revenue for fiscal year 2022 increased by 16.5% to $59.4 billion, profit per share increased by 6.8% to $12.64 per share, and non-GAAP or adjusted profit per share increased by 28% to $13.84 per share. Caterpillar's ME&T free cash flow was $5.8 billion for the full year, and $6.7 billion was returned to investors through dividends and share repurchases. Still, the cash balance was strong at the end of the year, standing at $7 billion.

Caterpillar is in a favorable position because the transition to a cleaner energy source will support increased commodity demand. Therefore, there will be a greater need for Caterpillar machinery, which will expand Caterpillar’s total addressable market. Even though commodity prices have been falling over the past few months, strong demand for machinery continues to be in the Resource Industries business segment. Caterpillar anticipates that production and utilization levels will continue to be at elevated levels.

Caterpillar anticipates strong growth in fiscal year 2023. It expects sales to rise due to lower prices. Furthermore, operating profit is expected to rise versus 2022 as a result of price increases, which will offset higher costs due to higher inflation figures.

When BHP Group Limited (BHP), Caterpillar, and Finning International (FINGF) announced an agreement to replace BHP's entire haul truck fleet at the Escondida Mine in Chile (the world's largest copper producing mine), which is a significant step in its journey toward transitioning to a more sustainable energy source. BHP will replace one of the industry's largest mixed fleets, which currently consists of over 160 haul trucks, with new Caterpillar 798 AC electric dry haul trucks. This fleet is one of the largest in the industry. The deliveries will begin in 2023 and continue for a total of 10 years. Through the introduction of zero-emission trucks, BHP will be able to realize its decarbonization objectives and meet its ESG commitments.

Caterpillar Is A True Dividend Aristocrat

For many years, a large portion of Caterpillar's free cash flow is distributed to its shareholders, making the company a true dividend aristocrat. Caterpillar ME&T generated $3B in free cash flow during the fourth quarter, and the company distributed $1.5B of that to its shareholders through buybacks and dividends.

A view on Caterpillar's cash flow statements reveals that the company repurchases a large cash amount of shares relative to dividend payments. Repurchasing shares is a tax-efficient way to return value to shareholders. Moreover, it has advantages when the company repurchases shares in combination with a dividend payment. Reducing the number of outstanding shares increases earnings per share and dividends per share. And shares of Caterpillar could rise if Caterpillar purchases its shares on the open market, this will increase demand while decreasing supply.

In the current fiscal year, Caterpillar distributed more to its shareholders than it generated in free cash flow.

Due to Caterpillar’s share buybacks, the shares outstanding has fallen from 660 million in 2013 to 520 million in 2023 (a decrease of 2.4% per year).

Caterpillar Is Favorably Valued

The price-to-earnings ratio chart is a widely used chart to gain insight into a stock's value. Ending 2017 with a record high P/E ratio renders any meaningful chart analysis over the period including 2017 meaningless. Therefore, I choose two charts that exclude 2017.

Since its 3-year average P/E is 18.7, the current ratio of 19.2 is in line with its historical figure.

Even in a higher interest rate environment, the average P/E ratio from 2000-2017 is about 16.6 (comparable to the average P/E ratio of 18.7 today).

Twenty-five analysts have raised their estimates for Caterpillar's financial performance, projecting annual EPS growth of about 10% for the company going forward. The forward 2024 P/E ratio is around 15, indicating an undervaluation.

If we multiply the expected earnings per share of $16.70 in 2024 by the average three-year P/E ratio of 18.7, we arrive at a share price of $312 at the end of 2024. So, Caterpillar’s shares seems undervalued at their current price of $265, and the shares could rise by 18%.

Conclusion

Caterpillar is a true dividend aristocrat, as the company has increased its dividend per share for many years. Investors who bought Caterpillar 10 years ago would have earned a good total return of 13.7% per year, but they should be aware of the high price volatility. Despite headwinds such as supply chain constraints and inflationary pressures, Caterpillar's results were impressive, total revenue for fiscal year 2022 increased by 16.5% and adjusted EPS increased by 28%. Sales increased strongly across all business segments, and the company is operating in an expanding total addressable market as the energy transition gains traction. To transition to a more sustainable energy source, BHP Group will replace its entire haul truck fleet at Chile's Escondida Mine with new AC electric dry haul trucks. The deliveries will begin in 2023 and will last for a total of 10 years. This will be a strong growth driver. Caterpillar returned $6.7 billion to shareholders from its $5.8 billion in free cash flow in 2022 through dividends and share repurchases. Furthermore, its stock valuation indicates that the company is favorably valued. The expanding total addressable market, strong growth figures, consistent dividend increases, and favorable stock valuation make the stock a good buy.

For further details see: