Will Caterpillar Dig Its Way To Another Buying Opportunity?

Key Points

• Caterpillar shares are falling on mixed results. 
• FX is cutting in the bottom line but that headwind is subsiding. 
• Capital returns and dividend growth is on track for 2023. 

There is good news and bad news in Caterpillar’s NYSE: CAT Q4 results. Caterpillar shares are falling hard after the impact of FX was revealed to be greater than expected, that’s the bad news. The good news is that business is strong, growth is on the table, cash flow is robust, and capital returns are flowing.

While near-term headwinds like valuation may weigh on the price action this stock should find a bottom soon, and it might be closer than you expect. Share of Caterpillar broke out to new all-time highs in the first week of 2023, which is a very bullish signal. The previous all-time high near $245 is a very good candidate for strong support to kick in and the outlook and capital returns are 2 good reasons to believe it will. 

Caterpillar Falls On Mixed Results 

Caterpillar, unlike dividend-payers Whirlpool Corporation NYSE: WHR and United Parcel Services NYSE: UPS, reported mixed results and sent its shares moving lower. The difference is that Caterpillar, unlike the others, reported top-line strength and bottom-line weakness that has the market running scared.

The caveat is that FX is the culprit, FX conversion from offshore business cut deeply into the bottom line and that headwind is diminishing rapidly. The FOMC is still in support of the dollar, but now there are so many other central banks tightening the reins the Dollar Index has corrected more than 10% and it may fall even further. 

So, Caterpillar reported $16.6 billion in net revenue for a gain of 20% over last year that beat the Marketbeat.com consensus by nearly 500 basis points. The strength was driven by gains in all major segments led by Machinery, Energy & Transportation. As mentioned, the earnings were impacted by FX, which cut $0.41 off the bottom line.

The mitigating factors here are that the adjusted operating margin improved by 560 basis points YOY and helped to drive robust cash flow for the year. The company reported $7.8 billion in operating cash flow which is $1.1 billion more than capital returns and has the cash balance in good shape at $7 billion despite CAPEX and reinvestment in the company. 

Caterpillar does not give guidance, but the outlook for growth in 2023 is favorable. The company’s business is being supported by the ramp of capital projects in the wake of the pandemic as well as the rebound in oil-field spending. That has the entire oil-field services industry moving higher, not just Caterpillar, and will be a story for investors to monitor in 2024. 

Caterpillar Capital Returns Are Safe 

There is no expectation for Caterpillar to cust or suspend its capital returns, the opposite. The company is paying only 36% of its earnings in dividends and has room to increase the payout and continue repurchasing shares. The problem is the valuation, trading at 18.75X its earnings. This Dividend Aristocrat is offering one of the less attractive value-yield combinations, and this may weigh on the price action. The upshot is that a correction to firmer support will increase both the yield and the value. 

The analyst sentiment is noteworthy as well. The analysts' sentiment is firming, and that includes the price target. The current consensus has the stock trading about 3% lower than it is now but at the $240 level and consistent with key support targets at or below the previous all-time high. Assuming the market follows through on this opportunity, the stock should bounce from this level and enter a consolidation if it doesn’t rebound.