Caterpillar’s dividend is sustainable through the economic cycle.
Cyclical earnings but a non-cyclical dividend
Lee Samaha (Caterpillar): The heavy equipment company might seem an odd choice to fit the bill here, but hear me out. While the company’s revenue and earnings will always ebb and flow with its key end markets, its free cash flow (FCF) generation will likely cover its dividend across various market conditions. That makes it a good “go-to” stock for income-seeking investors in a stock market downturn.
In other words, if Caterpillar’s stock is falling, its dividend yield will rise, and since its dividend is sustainable, investors can have confidence buying the stock for its yield.
Let’s play with some numbers to demonstrate this.
Caterpillar’s sustainable dividend
The company’s current dividend payment is around $2.6 billion. However, management’s estimate for its machine, energy, and transportation (ME&T) FCF through the cycle is $5 billion to $10 billion. In case you are wondering, Caterpillar defines its FCF to eliminate the noise around its FCF figure created by its financial arm.
The FCF target range recognizes that its revenue and earnings are volatile and depend on market conditions in industries like construction, mining, energy, and infrastructure. Still, the key point is that even at the bottom of the cycle, $5 billion in FCF will easily cover its $2.6 billion dividend. In fact, there’s a strong case for arguing that Caterpillar should be more aggressive in increasing its dividend.
In addition, Caterpillar’s focus on growing its less cyclical services business (aiming to double services revenue from $14 billion in 2016 to $28 billion in 2026) will reduce cyclicality and improve FCF generation in the future.
