Investors Should Not Buy Caterpillar Ahead of Its Earnings

Dividend Stocks

So far, 2020 has been a difficult year for long-term investors in Caterpillar (NYSE:CAT) stock. In 2020, CAT stock is down about 23%.

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However, that number gives only half the story. On March 12, the shares hit a 52-week low of $87.50. Now they are hovering around $114. In other words, over the past six weeks, CAT stock is actually up about 28%. Thus, a tug of war between bears and bulls is on.

The heavy equipment maker is slated to report its first-quarter earnings on Apr. 28. If you are not yet a shareholder, you may want to analyze the company’s metrics before buying its shares. Investors with a two-to-three-year time horizon may consider adding CAT stock to their portfolios if its price declines toward $100. Here’s why.

The Pandemic and CAT Stock

Caterpillar, a member of the Dow Jones Industrial Average. is the world’s leading manufacturer of construction and mining equipment, diesel and natural gas engines, industrial gas turbines and diesel-electric locomotives.

In late March, the company withdrew its 2020 earnings forecast and suspended some of its operations in response to the coronavirus. The company’s press release noted that the outbreak was impacting its supply chain. Caterpillar is a major manufacturer with a global supply chain.

The announcement further stated that, “the magnitude of the COVID-19 pandemic, including the extent of any impact on Caterpillar’s business, financial position, results of operations or liquidity, which could be material, cannot be reasonably estimated at this time.”

Later in March, the company said that it would also refrain from increasing the salaries of any of its employees.

Bloomberg has recently reported that the company’s management is in talks with banks for a $3 billion loan facility.

What to Expect From Caterpillar’s Q1 Earnings

The current uncertainty regarding the state of the economy worldwide makes Caterpillar’s upcoming Q1 results even more important than previous quarters.

When the company announced its fourth-quarter results in late January, the Street was not very impressed.  Although the firm’s Q4 earnings topped Wall Street’s low average outlook, its revenue fell short of the mean estimate.

Its 2019 revenue dropped 1.7%. Management also warned that its 2020 earnings would fall short of analysts’ average estimate.

Since January 2018, CAT stock has been in a multi-year decline. In January 2018,  it was trading just below $175. Before it released its Q4 earnings, the shares traded around $140.

Over the past two years, the company has suffered through the uncertainty created by the U.S.-China trade wars. When the novel coronavirus first started in China, analysts warned that demand would drop in this key market.

And now economists are warning of a global recession. The U.S. economy had been in expansion mode for a decade. But that has changed this year. Therefore, Caterpillar’s results probably won’t be very strong.

Very few companies, if any, will be able to avoid being hurt by  the coronavirus pandemic. If Caterpillar’s Q1 earnings and its 2020 guidance are worse than expected, then the shares may start another leg down.

Is Caterpillar’s Dividend Safe?

Most investors love receiving dividends from their stocks. And CAT stock has been a reliable dividend payer for decades. The board has also been increasing the annual payout amount for more than a quarter century. Its dividend yield stands at 3.6%.

Yet, amid the current economic realities, dividends are not as safe as they used to be. Corporations across the U.S. are cutting or eliminating  their dividends.

Companies cannot afford to pay out more in dividends than they have earned. And many firms’ operating cash flows are coming under serious pressure.

To the relief of CAT investors, in early April, Caterpillar’s board announced that it would be maintaining its dividend. In previous years, its dividend has been well-covered by its profits and cash flow.

However, in the upcoming Q1 release, there may be an update regarding the future of the dividend. If the board announces a dividend reduction, then CAT stock may be adversely affected. Although I am not expecting a dividend cut, I believe the firm may decide not to increase its dividend this year.

Finally, investors may be interested to know that in recent weeks, shares of the heavy machinery manufacturer have been downgraded by several  analysts. For example, according to Bank of America, Caterpillar’s exposure to the energy industry will likely be a drag on its earnings and the stock price.

The Bottom Line on CAT Stock

In 2020, many industries’ earnings are likely to drop. Therefore, companies may announce further steps to keep their financials sound, including cost-cutting measures and cash-raising strategies.

Caterpillar is not an ordinary stock. It is, in fact, a bellwether for both the domestic and global economy. A gloomy outlook could easily lead this industrial giant’s stock price back to the 52-week low it reached in mid-March. If the shares decline, I would look to be a buyer of CAT stock between $100 and $110.

If you already own Caterpillar, you may want to wait and ride out the choppy waters. Alternatively, you may consider initiating an ATM covered call position with, for example, a horizon of almost two months. A covered call that expires on June 19 would decrease the volatility of your portfolio, offer some downside protection and enable you to participate in a potential rally.

Finally, those investors who would like some exposure to Caterpillar but are nervous about its prospects this year may consider buying into an exchange-traded fund (ETF) that has CAT stock as a holding. Examples of such ETFs include the Industrial Select Sector SPDR Fund (NYSEARCA:XLI), the SPDR Dow Jones ETF (NYSEARCA:DIA) and the Vanguard Industrials ETF (NYSEARCA:VIS).

Tezcan Gecgil has worked in investment management for over two decades in the U.S. and U.K. In addition to formal higher education in the field, she has also completed all 3 levels of the Chartered Market Technician (CMT) examination. Her passion is for options trading based on technical analysis of fundamentally strong companies. She especially enjoys setting up weekly covered calls for income generation. As of this writing, Tezcan Gecgil did not hold a position in any of the aforementioned securities.

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