Even blue chip dividend stocks can fall on hard times, especially when they operate in highly cyclical industries that depend on volatile commodity prices.

Such was the case with Caterpillar (CAT), which despite an impressive track record of growing its dividend at an average rate of 11% over the past 20 years, was forced to freeze its pay increases for eight consecutive quarters during the worst industry downturn in decades.

However, now it appears as if the worst is over, so let’s take another look at Caterpillar to see how its fundamentals have held up during this most recent industrial recession and if today could be a reasonable time to consider adding the stock to a diversified dividend growth portfolio.

Business Overview

Founded in 1925 in Peoria, Illinois, Caterpillar is the world’s largest industrial machine maker, with its hands in all major infrastructure industries.

The company manufactures and sells construction and mining equipment, diesel and natural gas engines, industrial gas turbines, and diesel-electric locomotives.

A meaningful amount of Caterpillar’s revenue is also tied to higher-margin, less volatile aftermarket parts and components; however, the company does not disclose the size of its aftermarket business.

Source: Caterpillar Investor Presentation

The company operates through four main business segments.

Construction Industries (40% of 2016 sales, 47% of 2016 segment profits): makes backhoes, site prep tractors; excavators; and motor graders, pipelayers, telehandlers, cold planers, asphalt pavers, compactors, road reclaimers, and wheel and track skidders and feller bunchers.

Resource Industries (15% of 2016 sales, -30% of 2016 segment profits): produces electric rope and hydraulic shovel, landfill and soil compactors, dragline, large wheel loader, track and rotary drills, electronics and control systems, work tool, hard rock vehicle and continuous mining systems, scoops and haulers, wheel tractor scrapers, wheel dozers products;continuous miners; and mining, off-highway, and articulated trucks.

Energy & Transportation (37% of 2016 sales, 63% of 2016 segment profits): offers reciprocating engine powered generators set, centrifugal gas compressors, diesel-electric locomotives and components, and other rail-related products and services.

Financial Products (8% of 2016 sales, 20% of 2016 segment profits): primarily offers financing for Caterpillar equipment, machinery, and engines, as well as dealers; property.

In general, Caterpillar makes most of its money from the road construction and heavy construction industries, with about 50% of sales from North America.

Business Analysis

You typically don’t find companies with lengthy dividend growth track records in capital intensive and highly cyclical industries.

That’s because high fixed costs and volatile revenues, which are heavily influenced by global commodity markets, make for extremely unpredictable earnings, cash flows, margins, and returns on capital over time.

Source: Simply Safe Dividends

However, just because an industry is volatile doesn’t mean that select, best-in-breed industry leaders can’t make great dividend growth stocks. That’s because the capital intensive nature of the industry also makes Caterpillar’s moat very wide.

Specifically, the company has numerous competitive advantages that allow it to maintain strong pricing power for those products that are ordered (even if the volume decreases during an industrial recession).

This is because the products Caterpillar manufactures are typically very complex and increasingly high-tech, and the end consumer is most concerned with highly reliable and rugged products (that can operate in extreme climates where temperatures vary from -40F to 120F) from a brand they know and trust.

The company’s large global distributor network (Caterpillar sells its products to dealers who sell them to end users across different markets) is also a major competitive advantage.

Caterpillar’s network consists of about 150,000 global independent contractors who have strong local relationships with end users. To put this in perspective, Caterpillar’s largest rival, Japan’s Komatsu, is about half the size.

Why is a large dealer network so important for Caterpillar in the heavy equipment market?

A machine that breaks can stop an entire job – restarting work in a few hours compared to a few days can make or break a project’s financial and operational objectives.

Therefore, large dealers with plenty of parts and technicians are a big selling point influencing a customer’s purchase decision – a rapid response rate to machine breakdowns is essential.

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