Caterpillar (NYSE: CAT)
QVI Research Report | Initial Coverage | July 2023
Summary
Caterpillar provides customers with reliable, high-quality products while offering the lowest total cost of ownership, positioning the construction equipment manufacturer as one of the world’s most valuable and recognizable brands.
Along with solid fundamentals and low downside risks, the market continually overbuys or undersells stock, thus keeping valuations at fair value.
In its initial coverage of Caterpillar, QVI rates the company as a long-term buy-and-hold industrials staple serving the growing infrastructure space.
However, QVI initiates the stock at hold or watch due to valuations.
Nonetheless, some investors may see the shares as not overvalued and worthy of an initial position for a long-term hold or add to an existing low-cost basis.
When referencing this report, premium (paying) subscribers can access their Quality Value Investing (QVI) Glossary of Investing Terms and Metric Targets. Unless noted, all data presented is sourced from Seeking Alpha Premium as of the market close on July 3, 2023, and intended for illustration only. If reading this in your email, consider viewing in the Substack App for a more inclusive experience.
Caterpillar Value Proposition
QVI Research Report’s value proposition section provides a brief synopsis of the company’s business model, major-exchange listing, stock symbol, market capitalization, and dividend-paying status. In addition, it defines the competitive advantages of a company’s products or services to its customers compared to the industry, including the stock’s historical performance vs. the sector and market.
Caterpillar, Inc. CAT 0.00%↑ is a dividend-paying large-cap stock in the industrials sector’s construction machinery and heavy transportation equipment industry. CAT was added to the QVI Expanded Portfolio on July 3, 2023, at $247.33 a share.
Caterpillar Inc. manufactures and sells construction and mining equipment, diesel and natural gas engines, and industrial gas turbines.
Its Construction Industries segment offers asphalt pavers, compactors, cold planers, motor graders, pipelayers; forestry machines, road reclaimers, wheel excavators, telehandlers; backhoe, compact track, multi-terrain, skid steer loaders, and track-type loaders; and track-type tractors.
The company's Resource Industries segment provides electric rope and hydraulic shovels, draglines, rotary drills, hard rock vehicles, track-type tractors, mining trucks, longwall miners, wheel loaders, off-highway and articulated trucks, wheel tractor scrapers, wheel dozers, landfill and soil compactors, machinery components, electronics and control systems, select work tools, and hard rock continuous mining systems.
Its Energy & Transportation segment offers reciprocating engine-powered generator sets; reciprocating engines and integrated systems for the power generation, marine, oil, and gas industries; turbines, centrifugal gas compressors, and related services; remanufactured reciprocating engines and components; and diesel-electric locomotives and components, and other rail-related products.
The company's Financial Products segment provides operating and finance leases, installment sale contracts, working capital loans, wholesale financing, and insurance and risk management products.
Its All Other operating segment manufactures filters and fluids, undercarriage, ground engaging tools, fluid transfer products, precision seals, rubber sealing and connecting components; parts distribution; integrated logistics solutions and distribution services; and digital investments services.
The company was formerly known as Caterpillar Tractor Co. and changed its name to Caterpillar Inc. in 1986. Caterpillar was founded in 1925 and is headquartered in Irving, Texas, USA.
QVI’s value proposition elevator pitch for Caterpillar:
Caterpillar provides customers with reliable, high-quality products while offering the lowest total cost of ownership, positioning the construction equipment manufacturer as one of the world’s most valuable and recognizable brands.
Performance vs. Sector and Market
The chart below illustrates CAT’s performance against the Industrial Select Sector SPDR® Fund ETF (NYSE: XLI) and the SPDR® S&P 500 ETF Trust (NYSE: SPY).
For example, CAT has outperformed its sector and the broader market in total return during the trailing three-year coverage timeframe.
Due Diligence Resources
For a more in-depth analysis of the all-important value proposition, visit Caterpillar’s investor relations webpage and its most recent Form 10-K Annual Report submitted to the U.S. Securities and Exchange Commission or SEC.
QVI’s value proposition rating for Caterpillar: Bullish.
CAT Total Returns vs. XLI and SPY Caterpillar Inc (CAT) Total Return: +106.10% Industrial Sel Sector SPDR ETF (XLI) TR: +63.00% SPDR S&P 500 ETF Trust (SPY) Total Return: +48.57% Three-Year Trailing (as of July 3, 2023)
CAT Shareholder Yields
QVI Research Report’s shareholder yields section uncovers the equity bond rate of the company’s common shares. It aims to quantify the yields on earnings, free cash flow, and dividends to measure how the targeted stock compares to the prevailing yield on the 10-Year Treasury benchmark note.
Earnings and Free Cash Flow Yields
CAT’s earnings yield traded below the QVI targeted floor at 5.47%, as demonstrated in the below chart. In addition, at 4.88%, CAT’s free cash flow yield traded under the threshold.
As inverse valuation multiples, the weighted earnings and free cash flow yields suggest that CAT trades at fair market value. QVI will further explore valuation multiples later in this report.
Dividend Yield
Caterpillar offers a modest forward dividend yield of 1.94%, supported by a conservative 30.19% payout ratio, thus indicating a dividend rate with room for additional annual increases.
CAT yielded 4.36% from an annual payout of $5.20 on a split- and dividend-adjusted cost basis of $119.37 per share on July 2, 2020, using the three-year trailing performance cost basis. Thus, the sample yield-on-cost basis was +242 basis points (bps) above the forward yield.
Average of Shareholder Yields
Quality Value Investing takes the average of the three shareholder yields to measure how the stock compares to the prevailing yield of 3.86% on the 10-Year Treasury benchmark note. For example, the average shareholder yield for CAT was 4.10% or +24 bps above the 10-Year and 4.90% or +108 bps above the Treasury yield when using the trailing three-year yield-on-cost basis.
QVI’s shareholder yields rating for CAT: Neutral.
CAT Shareholder Yields
Caterpillar Inc (CAT) Price: $247.48
Caterpillar Inc (CAT) Earnings Yield: 5.47%
Caterpillar Inc (CAT) Free Cash Flow Yield: 4.88%
Caterpillar Inc (CAT) Dividend Yield: 1.94%
One-Year Trailing (as of July 3, 2023)Caterpillar Fundamentals
QVI Research Report’s fundamentals section measures the performance strength of the company’s senior management by analyzing revenue growth, net profit margin, and returns on equity and invested capital.
Revenue Growth and Net Profit Margin
Per the below chart, Caterpillar had positive three-year annualized single-digit revenue growth of 3.37%, underperforming the 12.19% median growth of the industrials sector. However, the company’s most recent one-year growth was a promising 17.14%.
Farther down the income statement, Caterpillar had a trailing three-year low double-digit net profit margin of 10.96%, outperforming the sector’s median net margin of 6.34%
Returns on Equity and Invested Capital
Caterpillar’s management produced a trailing three-year return on equity or ROE of 35.44%, far surpassing the targeted threshold and the sector’s median ROE of 13.83%
Stock buyback programs often elevate ROE. For example, Caterpillar’s board of directors authorized a $15 billion repurchase program in May 2022. The share price has risen about 22% since the announcement.
At 10.78%, Caterpillar’s three-year return on invested capital, or ROIC, was below the QVI threshold but outperformed the sector’s median ROIC of 7.00%, indicating that its senior executives are above-average capital allocators.
However, Caterpillar’s ROIC barely covers its weighted average cost of capital, or WACC, of 8.85%. (Source of WACC: GuruFocus).
Positive revenue growth, a low double-digit profit margin, and sector-beating returns on equity and invested capital suggest that Caterpillar’s management continues its long history of conservative yet 2nd level performance in the Lone Star State.
QVI’s fundamentals rating for Caterpillar: Bullish.
CAT Returns on Management
Caterpillar Inc (CAT) Revenue (3y Growth): 3.37%
Caterpillar Inc (CAT) Profit Margin (3y Median): 10.96%
Caterpillar Inc (CAT) ROE (3y Median): 35.44%
Caterpillar Inc (CAT) ROIC (3y Median): 10.78%
Three-Year Trailing (as of July 3, 2023)CAT Valuation, Risks, and Investment Thesis
Next, QVI dives into the valuation multiples, downside risks, and overall investment thesis of Caterpillar, Inc. (CAT), including potential catalysts. So let’s dig further after reading the required disclosures and background information.
Disclosure: I/we have no beneficial position through direct ownership of any stock mentioned in this report. I wrote this report myself, and it expresses my own opinions. I am not receiving compensation for it other than from Substack paid subscriptions. I have no business relationship with any company whose stock is mentioned in this article.
Additional Disclosure: Quality Value Investing by David J. Waldron’s primary ticker research reports are for informational purposes only. The accuracy of the data cannot be guaranteed. Narrative and analytics are impersonal, i.e., not tailored to individual needs nor intended for portfolio construction beyond his family portfolio, which is presented solely for educational purposes. David is an individual investor and author, not an investment adviser. Readers should always engage in their own research or due diligence and consider (as appropriate) consulting a fee-only certified financial planner, licensed discount broker/dealer, flat fee registered investment adviser, certified public accountant, or specialized attorney before making any investment, income tax, or estate planning decisions.
About the Writer
David J. Waldron is contributing editor of Quality Value Investing and author of the international-selling book, Build Wealth with Common Stocks: Market-Beating Strategies for the Individual Investor. David’s mission is to inspire the achievement of his readers’ financial goals and dreams. He received a Bachelor of Science in business studies as a Garden State Scholar at Stockton University and completed The Practice of Management Program at Brown University.
Preview David’s Book
Readers can preview Build Wealth with Common Stocks below, including links to online booksellers worldwide.
Bonus: Founding Members of QVI on Substack are eligible to receive an author-personalized complimentary copy of the case laminate hardcover edition of the book.