Caterpillar is an attractive long-term investment with a healthy dividend and trading at an attractive price relative to its long-term value. Near term technical conditions and fear related to the China "trade war" have already caused the share price to sell off too far (management just provided weaker 2019 guidance than previously expected). But because of the attractive premium income, and because we understand near-term volatility can drive the share price lower, we've elected to sell the puts (instead of buying the shares outright), which gives us the chance to pick up the shares at an even lower price (if they fall below the strike price and get put to us before expiration). Important to note, because near-term volatility and fear are higher, so too is the premium income available in the options market and on this trade specifically.
Caterpillar announced earnings on Monday, and the market didn't like it. In particular, the company's revenue continued to grow across segments (construction revenue was up 8%, the resource industries segment grew 21%, and the energy and transportation segment grew 11%), but margins were weaker than expected (particularly in the construction segment where operating margin declined to 14.8% from 15.8%) and management provided lower than EPS guidance for 2019 than the Street was expecting (2019 GAAP EPS guidance of $11.75 to $12.75, versus the Street's expectation of 12.73). Global trade headwinds and fear (particularly related to China "trade wars") have been impacting the stock. However, in the long-term, the shares are increasingly attractive.
In the long-term, Caterpillar shares are attractive because revenue is growing (and is expected to keep growing), but near-term volatility and fear have caused the shares to sell-off to an increasingly attractive price. In particular, even though margins, earnings and guidance came in below expectations, revenue continue continues to grow, and revenue and EPS are expected to keep growing.
Briefly, if you don't know, Caterpillar engages in the manufacture of construction and mining equipment, diesel and natural gas engines, industrial gas turbines, and diesel-electric locomotives. It operates through the following segments: Construction Industries, Resource Industries, Energy and Transportation, Financial Products, and All Other. The Construction Industries segment supports customers using machinery in infrastructure and building construction applications. The Resource Industries segment is responsible for supporting customers using machinery in mining and quarrying applications and it includes business strategy, product design, product management and development, manufacturing, marketing and sales and product support. The Energy and Transportation segment supports customers in oil and gas, power generation, marine, rail, and industrial applications. The Financial Products segment offers a range of financing alternatives to customers and dealers for Caterpillar machinery and engines, solar gas turbines, as well as other equipment and marine vessels. The All Other segments includes activities such as; the business strategy, product management and development, and manufacturing of filters and fluids, undercarriage, tires and rims, engaging tools, and fluid transfers. The company was founded on April 15, 1925 and is headquartered in Deerfield, IL.
1. Revenue and Earnings Growth
As mentioned above, Caterpillar's revenue continues to grow. Here are more specific details from a recent Morningstar report, by segment, emphasis ours:
Caterpillar shares declined nearly 10% after the company reported fourth-quarter adjusted EPS of $0.44, 15% below consensus estimates. The main contributor to the miss was lower operating margin in construction industries. Management also shared its 2019 GAAP EPS guidance of $11.75 to $12.75, which was below our estimate of $12.81.
The performance of the construction industries segment during the quarter was the biggest disappointment. While revenue grew approximately 8% year over year, operating margin declined to 14.8% from 15.8%, well below our estimate of 20.7%. Issues cited for the margin decline included weak demand in Latin America and the Middle East. At the same time, freight and materials costs were elevated. Consistent with our research, management was upbeat on U.S. construction activity for 2019.
Caterpillar's resource industries segment maintained its upward growth trajectory, increasing revenue 21% year over year, and segment operating margin increased to 14.3% from 9.1%. Mining customers continued to invest in capital equipment as commodity prices remain supportive. Management remained positive about its 2019 outlook for the segment due to ongoing reductions in customers’ idle assets. Additionally, there are early indications of strong demand for quarry and aggregate machinery.
Caterpillar’s energy and transportation segment also showed healthy growth in the quarter. Revenue increased 11% year over year, while operating margin increased to 17.2% from 15.5% in the year-ago period. Strong power generation sales, especially to data centers, contributed to the segment’s performance. Rail service revenue also increased. A strong U.S. economy and robust demand for gas compression equipment are likely to boost 2019 segment revenue 2019.
2. Attractive Growing Dividend
Also very important, Caterpillar continues to generate plenty of healthy income to support its continuing long-term dividend growth.