The Best Construction Equipment Maker for Income Investors

By Anh HOANG - October 19, 2012 | Tickers: CAT, MTW, TEX | 0 Comments

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Buy low, sell high! Investing is that simple. But the majority of investors often do the opposite, because human beings in general are quite emotional. A large price decline will make us scared, and cause us to sell without thinking about the fundamentals. This crowd effect creates opportunities to buy good stocks at ridiculously cheap prices. As a value investor, I often begin my search for suitable investments by looking at stocks that are selling at a 52-week low, then digging deeper into the ones I find interesting.

What stock now?

Following that philosophy, I recently noticed Caterpillar (NYSE: CAT), which is selling at its 52-week low. It is currently trading at $84.96 per share, 31.5% lower than its 52-week high of $116.2. 

But in the longer horizon, CAT has delivered a nice return for those who bought at the lows in 2009. It was cost less than $25 back then, and if those investors sold the stock today for $84.96, they'd realize an annual compounded return of 50.34%. 

Business

CAT is the world’s leading manufacturer of construction and mining equipment, diesel and natural gas engines, and gas turbines. In addition, it also provides retail and wholesale financing alternatives for its own products to dealers globally. CAT’s products are distributed mainly via its dealer network, with 50 located domestically in the US and 141 overseas in 182 countries. The company's international operations are key, considering that 70% of CAT's sales were from outside the US in fiscal 2011. 

Operating performance

The above description may make investors feel that CAT has a strong foundation for its business, but we need to dig into its operating figures to see whether it’s a good or not. We will have a look at its profitability, including operating margin, net margin, and ROE; its balance sheet strength, including D/E ratio and interest coverage; its dividend yield and its valuation, including P/E, P/B and EV/EBITDA.

Currently, CAT is trading at $85.56 per share; the total market capitalization is $54.1 billion. The enterprise value is at $88.32 billion, so the EV/EBITDA remains at 7.86x.

If we look at the trailing twelve months, CAT’s operating figures look quite good. The return on equity is very high, partly due to high leverage level, which CAT is using to the fullest. Investors might be scared when they see that the debt/equity ratio is quite high. However, CAT can generate more than enough earnings to cover its interest payments quite comfortably. The ability to pay interest is indicated by interest coverage ratio, and the higher the ratio, the stronger CAT’s financial strength is. CAT’s current interest coverage is 6.88x, which is considered high.

Dividends

The good thing about CAT for income investors is that the company has had a history of paying increasing and consistent dividends for the last 10 years.

In 2002, it paid out $0.7 dividend per share; and in 2011, the dividend per share was $1.8. The annual compounded growth for its dividend payment is 9.9%.

Industry peers

In the commercial vehicle and truck industry, CAT’s industry peers are Manitowoc Company (NYSE: MTW) and Terex Corporation (NYSE: TEX).

Among the three, CAT has the best operating margin (13.1%), whereas MTW and TEX each have an operating margin around 8.8%. In addition, it enjoys the highest return on equity. That is partly due to its higher leverage than Terex, although CAT's leverage is much lower than Manitowoc. Terex hasn’t paid any dividends, and Manitowoc's dividend yield is quite low at 0.59%. Among the three, only CAT has consistently paid increasing and sustainable dividends.

My foolish take

CAT enjoys the best operating performance among the three, keeps paying good dividends, and it has the lowest valuation. Its P/E is only 8.86x, whereas Manitowoc’s is 21.8x and Terex’s is 18.7x. The current decrease in the share price creates an opportunity to buy CAT at its 52-week low. I think CAT is a good stock to buy for long-term income investors who want a diversified portfolio.

Know What You Own

Caterpillar is the market share leader in an industry in which size matters, and its quality products, extensive service network, and unparalleled brand strength combine to give it solid competitive advantages. Read all about Caterpillar's strengths and weaknesses in the Fool’s brand new report. Just click here to access it now.

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