The Safety Net: Caterpillar Stock Gets An Upgrade
In August, Safety Net Pro downgraded construction giant Caterpillar (NYSE: CAT) from a “B” to a “C” rating because analysts lowered estimates for 2016 free cash flow.
Generally, I couldn’t care less what analysts think…
But free cash flow estimates are a small part of the system’s model for rating dividend safety. And we rely on the analysts for a ballpark figure – since not all companies provide free cash flow guidance.
In Caterpillar’s case, the estimated dip to $2.25 billion from $2.56 billion was enough to set off a downgrade because the payout ratio would rise to more than 80%.
Payout ratio is the percentage of earnings or cash flow (I use cash flow) paid out in dividends. A payout ratio of 75% or less gives me confidence that the dividend is safe.
Let’s take a look at whether Caterpillar still deserves a “C” rating.
A Brighter Forecast
Caterpillar is an investor favorite thanks to its 3.7% yield and 22-year history of annual dividend increases. That’s a nice feather in its cap.
Companies with long histories of annual dividend raises often do their best to keep those streaks alive.
Caterpillar’s cash flow has been steadily declining over the past 2 1/2 years, which isn’t great, but it can still cover the dividend.
What’s more exciting for Caterpillar shareholders is that analysts have raised free cash flow estimates since our August update.
They now expect Caterpillar to report $2.9 billion in cash flow at the end of the year – which exceeds their original forecast of $2.56 billion.
If they’re correct, Caterpillar’s payout ratio should drop to a comfortable 62% (from 80% in August).
Right now, my only concern is that cash flow has been dropping the past few years. We’ll want to see a reversal to feel entirely confident that the dividend is safe.
But the new lower expected payout ratio means Caterpillar gets an upgrade from August and is now “low risk” for a dividend cut.
Dividend Safety Rating: B
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