Final Group Report

MBA 5350 Corporate Finance

April 9, 2016

Introduction

Caterpillar Inc. traces its origins to the 1925 merger of the Holt Manufacturing Company and the
C. L. Best Tractor Company, creating a new entity, the California-based Caterpillar Tractor
Company. In 1986, the company re-organized itself as a Delaware corporation under the current
name: Caterpillar Inc. Caterpillar's headquarters are located in Peoria, Illinois, United States1.
Primary Business

With 2015 sales and revenues of $47.011 billion, Caterpillar is the worlds leading manufacturer
of construction and mining equipment, diesel and natural gas engines, industrial gas turbines and
diesel-electric locomotives. The company principally operates through its three product segments
- Construction Industries, Resource Industries and Energy & Transportation - and also provides
financing and related services through its Financial Products segment. Caterpillar also provides
financing for our products through Cat Financial, a captive finance company with over $35
billion in assets.
Categories of Business Organization
1. Machinery, Energy & Transportation: represents the aggregate total of Construction Industries,
Resource Industries, Energy & Transportation and all other operating segments and related
corporate items and eliminations.
Construction Industries
The Construction Industries product portfolio includes the following machines and
related parts: backhoe loaders, compact wheel loaders, small track-type tractors, small
wheel loaders, track-type loaders, medium track-type tractors, skid steer loaders, mini
excavators, select work tools, multi-terrain loaders, small, medium and large track
excavators, motor graders, medium wheel loaders, wheel excavators, Telehandlers,
compact track loaders, pipe layers and mid-tier soil compactors.
Resource Industries

The Resource Industries product portfolio includes the following machines and related
parts: electric rope shovels, large track-type tractors, wheel tractor scrapers, draglines,
large mining trucks, wheel dozers, hydraulic shovels, longwall miners, machinery
components, track and rotary drills, large wheel loaders, electronics and control systems,
1 "Caterpillar Tractor Co. List of Deals". Lehman Brothers Collection. President and Fellows of
Harvard College. 2010. Archived from the original on 2010-11-06. Retrieved 2016-04-07
http://www.library.hbs.edu/hc/lehman/chrono.html?company=caterpillar_tractor_co
2

high wall miners, off-highway trucks, select work tools, hard rock vehicles, articulated
trucks, hard rock continuous mining systems, continuous miners, and scoops and haulers.
Energy & Transportation

The Energy & Transportation portfolio includes the following products and related parts:
reciprocating engine powered generator sets;
reciprocating engines supplied to the industrial industry as

well as Caterpillar machinery;

integrated systems used in the electric power generation
industry;
turbines, centrifugal gas compressors and related services;
reciprocating engines and integrated systems and solutions

for the marine and oil and gas industries;

diesel-electric locomotives and components and other railrelated products and services.
2. Financial Products: primarily includes the companys Financial Products Segment. This

category includes Caterpillar Financial Services Corporation (Cat Financial), Caterpillar

Financial Insurance Services (Insurance Services) and their respective subsidiaries2.
Market

Through a global network of independent dealers and direct sales of certain products, Caterpillar
builds long-term relationships with customers around the world3.
Stock Exchange

In addition to the New York Stock Exchange, Caterpillars common stock is also listed on the
stock exchanges in France and Switzerland.

Number of Stockholders

Stockholders recorded at year-end 2015 totalled 30,274. Approximately 63% of Caterpillars

issued shares are held by institutions and banks, 32% by individuals and 5% by employees
through company stock plans3.
Stock price movement
2 Securities and Exchange Commission Form 10-K Annual report Filing Date: 2016-02-16 | Period of
Report: 2015-12-31 SEC Accession No. 0000018230-16-000410
3 Securities and Exchange Commission Form 10-K Annual report Filing Date: 2016-02-16 | Period of
Report: 2015-12-31 SEC Accession No. 0000018230-16-000410
3

From Mar 2011 until Mar 2016 stock prices have decreased -$29.58 i.e. -28.16% 4.

Major Competitors
Competitors in Construction Industry: Examples of global competitors include Komatsu Ltd.,

Volvo Construction Equipment (part of the Volvo Group), CNH Industrial N.V., Deere &
Company, Hitachi Construction Machinery Co., Ltd., J.C. Bamford Excavators Ltd., Doosan
Infracore Co. Ltd., and Hyundai Construction Equipment (part of Hyundai Heavy Industries). As
an example of regional and local competitors, Caterpillars competitors in China also include
Guangxi LiuGong Machinery Co., Ltd., Longking Holdings Ltd., Sany Heavy Industry Co., Ltd.,
Xiamen XGMA Machinery Co., Ltd., XCMG Group, The Shandong Heavy Industry Group Co.,
Ltd. (Shantui Construction Machinery Co., Ltd.), Strong Construction Machinery Co., Ltd., and
Shandong Lingong Construction Machinery Co., Ltd. (part of Volvo Group).
Competitors in Resource Industry: global surface competitors include Komatsu Ltd., Joy

Global, Inc., Hitachi Construction Machinery Co., Ltd., Volvo Construction Equipment, Atlas
Copco AB, and Sandvik Mining. Caterpillars global underground competitors include Joy
Global, Inc., Atlas Copco AB, Sandvik Mining and Zhengzhou Coal Mining Machinery Group
Co., Ltd.
Competitors in Energy & Transportation: Principal global competitors include Cummins Inc.,

Rolls-Royce Power System, GE Oil & Gas, GE Power & Water, Deutz AG and Wrtsil Corp.
Other competitors, such as MAN Diesel & Turbo SE, Siemens Energy, Rolls-Royce Marine,
Mitsubishi Heavy Industries Ltd., Volvo Penta, Weichai Power Co., Ltd., Kirloskar Oil Engines
4 http://www.reuters.com/finance/stocks/companyNews?symbol=CAT.N
4

Limited and other emerging market competitors compete in certain markets in which Caterpillar
operates. An additional set of competitors, including Generac Power Systems, Inc., Kohler Co.,
Inc., Aggreko plc and others, are packagers who source engines and/or other components from
domestic and international suppliers and market products regionally and internationally through
a variety of distribution channels. In rail-related businesses, Caterpillars global competitors
include GE Transportation, Vossloh AG, Siemens Akteingesellschaft, Alstom Transport SA, and
Voestalpine AG.
Competitors in Finance: Cat Financials competitors include Wells Fargo Equipment Finance
Inc., General Electric Capital Corporation and various other banks and financing companies. In
addition, many of Caterpillars manufacturing competitors own financial subsidiaries such as
Volvo Financial Services, Komatsu Financial L.P. and John Deere Capital Corporation that
utilize below-market interest rate programs (funded by the manufacturer) to assist machine
sales5.
Prospect

Cost management, restructuring actions and operational execution are helping the company
while sales and revenues remain under pressure from weak commodity prices and slowing
economic growth in developing countries6.
Caterpillars outlook for 2016 does not anticipate improvement in world economic growth or
commodity prices.
Caterpillar sees 2016 revenue falling within a range of $40-billion (U.S.) to $44-billion. The
midpoint of that range, $42-billion, is around $3.5-billion below its forecast in October.
It expects full-year 2016 earnings of $4.00 per share, excluding restructuring costs, compared
with the average estimate of $3.48 per share, according to Thomson Reuters I/B/E/S. Including
restructuring costs; the company said it expects 2016 EPS of $3.50 per share7.
News Analysis

Cost management, restructuring actions and operational execution are helping the company
while sales and revenues remain under pressure from weak commodity prices and slowing
5 Securities and Exchange Commission Form 10-K Annual report Filing Date: 2016-02-16 | Period of
Report: 2015-12-31 SEC Accession No. 0000018230-16-000410
6 http://business.financialpost.com/news/mining/caterpillar-results-reflect-huge-mining-slowdown
7 Caterpillar sees first-quarter revenue, profit below Wall Street estimates
http://www.reuters.com/article/us-caterpillar-outlook-idUSKCN0WJ1XV?type=companyNews
5

economic growth in developing countries. Caterpillar saved US $ 2.3 Billion by restructuring and
making its processes leaner and also fall in commodity prices meant a boon for the Caterpillar as
it saved 38% on cost of goods sold. From the analysis of the news and the major events it is
evident that Caterpillar has been fighting off the competition quite successfully and expanding its
process capabilities by businesses supplementing to its core business segments7.
Major Events

In 2010, D.R. Oberhelman is named Chairman of the Board;

In March 2010, Co. acquired the Inspection Products business from GE

Transportation's Intelligent Control Systems division;

In the same month, Co. acquired 100% of the equity in privately held JCS
Company Ltd;

In May 2010, Co. acquired 100% of the equity in privately held FCM Rail Ltd;

In August 2010, Co. acquired 100% of the equity in privately held Electro-Motive
Diesel, Inc;

In May 2011, Co. acquired 100% of the assets and certain liabilities of the U.K.
trackwork business from Balfour Beatty Rail Limited;

On July 8, 2011, Co. acquired Bucyrus International Inc. Bucyrus is a designer,

manufacturer and marketer of mining equipment for the surface and underground mining
industries;

In August 2011, Co. acquired 100% of the stock of Pyroban Group Limited;
On October 31, 2011, Co. acquired 100% of the equity in privately held MWM

Holding GmbH (MWM). MWM is a global supplier of sustainable, natural gas and
alternative-fuel engines. With the acquisition of MWM, Caterpillar expects to expand
customer options for sustainable power generation solutions;

In the second quarter of 2012, Co., through its wholly-owned subsidiary

Caterpillar (Luxembourg) Investment Co. S.A., completed a tender offer to acquire the issued
shares of ERA Mining Machinery Limited (Siwei), including its wholly-owned subsidiary
Zhengzhou Siwei Mechanical Manufacturing Co., Ltd;

On March 1, 2012, Co.'s subsidiary, Caterpillar Japan Ltd., acquired Caterpillar

Tohoku Ltd.

On April 12, 2012, Co. sold a part of its Bucyrus distribution and support business
to WesTrac Pty Ltd;

In 2012, The Caterpillar Visitors Center opens in Peoria, Illinois;

In 2013, Walter Berg AB is acquired by Caterpillar Inc. Berg is a leading

manufacturer of mechanically and electrically driven propulsion systems and marine controls
for ships. Headquartered in cker Islands, Sweden, Berg has designed and manufactured
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heavy-duty marine thrusters and controllable pitch propellers since 1929. Its proprietary
systems are employed in maritime applications throughout the world that require precise
manoeuvring and positioning. With the acquisition, Caterpillar will transition from selling
only engines and generators to providing complete marine propulsion package systems;

In 2014, Caterpillar expands Our Values in Action to include Sustainability;

October 2015, Caterpillar acquired 100 percent of the stock in privately owned
Rail Product Solutions, Inc. (RPS) from Amsted Rail Company, Inc. RPS is a leading North
American provider of mission critical track fastening products and integrated fastening
systems. The acquisition of RPS expands Caterpillars portfolio of track related products and
allows Caterpillar to provide more comprehensive solutions to Caterpillars customers;

In December 2015, Caterpillar acquired 100 percent of the stock of RDS

Manufacturing, Inc. (RDS). RDS, located in Broken Arrow, Oklahoma, is a privately owned
manufacturer of highly engineered turbo-machinery parts, primarily for the turbine engine
and aerospace markets;

2016 Caterpillar names Rimco, a privately-owned Puerto Rico-based company, as

the official Cat dealer for Cuba8.
Ratio Analysis
Liquidity - Current Ratio
201

201

2014

2013

2011

Caterpillar

1.31

1.39

1.40

1.43

1.34

Deere & Company

2.06

2.17

2.05

2.24

2.07

CMI Corporation

2.09

2.25

2.57

2.29

1.94

Caterpillar shows stable liquidity with a 5-year average of 1.37 for its current ratio. The current
ratio allows us to see with a quick overview at the companys current resources in terms of
liquidity. Higher liquidity means that the company has more available resources to deal with
shortcomings or new projects in the short term. The value can be found by dividing the
companys current assets (such as cash) over its current liabilities. Although its current ratio is
8 Securities and Exchange Commission Form 10-K Annual reports year 2011, 2012, 2013, 2014 &
2015 SEC Accession Nos. 0001104659-11-008938, 0000018230-16-000410, 0000018230-15-000061,
0000018230-14-000058, 0000018230-13-000075
7

stable, Caterpillar shows a lower ratio than that of its competitors. Deere shows a 5-year average
of 2.12 and CMI 2.23. Therefore, Caterpillar is, by comparison, less prepared to face
shortcomings when looking only at its liquidity.
Efficiency - Assets Turnover Ratio
201

201

2014

2013

2011

Caterpillar

0.58

0.65

0.64

0.77

0.83

Deere & Company

0.48

0.60

0.65

0.69

0.70

CMI Corporation

1.24

1.26

1.27

1.43

1.64

The assets turnover ratio demonstrates how quickly a company manages its assets. Efficient
management of assets helps prevent a build up of unsold inventory that would decrease in value
with time and increase storage related expenses. The ratio is calculated by dividing the
companys net sales over average total assets. Caterpillars asset turnover ratio is quite low, being
under 1. Its 5-year average for this ratio is 0.69, which is lower than CMI, but higher than Deere.
It is important to note here that all three companies have experienced a decrease in their turnover
ratio over the last five years. This trend can be observed by a slowing market for this particular
industry, making it increasingly difficult for these companies to sell their inventory as efficiently
as previous years.
Stability - Debt to Equity Ratio
201
2015

2014

2012

2011

Caterpillar

2.57

2.35

1.81

2.29

2.69

Deere & Company

5.47

4.08

3.36

4.74

3.91

CMI Corporation

0.22

0.22

0.23

0.12

0.14

Debt to equity ratio provides an indicator of the companys stability. If the company took on too
many debts, it will be burdened by regular principal and interest payments, and may have an
impact on the companys survival in the long-term. The ratio is calculated by dividing the
8

companys total liabilities over its total equity. From an accounting point of view, a lower ratio is
traditionally viewed as being an indication of stability, as it means the company is relatively
debt-free. Caterpillars 5-year average is 2.34, which is relatively high. This means that
Caterpillar has just a little over twice as many debts as equity. The rate is lower than that of its
competitor Deere, but higher than CMI, which has an extraordinarily low ratio.

Growth - Annual Revenue Growth

2015

2014

Caterpillar

14.81%

2013

2012

2011

9.54%

41.21%

-0.85%

15.51%

12.95

Deere & Company

19.97%

-4.57%

4.53%

23.10%

CMI Corporation

0.58%

11.10%

-0.19%

-3.96%

36.46%

In terms of growth, Caterpillar showed a 5-year average growth of 0.04%. It is important to

note, however, that there is a downward trend, as its annual revenue growth dropped from
41.21% in 2011, to a negative growth of -14.81% in 2015. This can be explained by the same
phenomenon affecting the turnover ratio: the market for this industry has taken a hit in recent
years. From this data, we can see, however, that Caterpillar was not the hardest hit: Deere ended
2015 with a worst annual revenue growth, which CMIs data showed more fluctuation. When
comparing this ratio to a debt ratio, we can explain that in times of recession, revenues will drop,
but companies burdened by heavy debts still have an obligation to make their regular payments.
Therefore, these companies having a higher debt ratio are more likely to have difficulty
maintaining growth.

Governance Analysis
Board Structure and background information

Caterpillars board structure includes four features: 1) Combined Chief Executive Officer and
Chairman of the board; 2) a Presiding Director who has broad authority over governance of the
Board; 3) Independent Directors; and 4) Committees composed entirely of independent directors9
Caterpillars Guidelines on Governance issues set the range for board members to be between 11
and 14. Currently the number of directors is 12 - within this range. Further, in line with the
requirements of the Guidelines10 and to ensure independence of the board, only two directors can
be non-independent at any point in time. According to the Guidelines, a director is independent
as long as he or she has no direct or indirect material relationship with the Company, either
directly or as a partner, shareholder or officer of an organization that has a relationship with the
Company.11 An annual review process based on New York Stock Exchange Standards of
Independence is in place to assess the independence of directors. Hence, out of the 12 directors
currently serving on the Board, 11 are independent. Only the Chairman of the Board who is also
CEO of the Company is non-independent. Independent Directors of the Board have business,
education, government and public policy background. They currently serve or have served as
chief executives and members of senior management of large public and private for profit
companies; as leaders of numerous nonprofit organizations; as U.S. federal and state government
officials; and as members of academia. 12 Directors are elected at each annual meeting to serve
for a one-year term. Detailed background information about Directors is given in the Appendix.
Presiding Director is elected from independent members of the Board. Currently, Chairman of
the Public Policy and Governance Committee serves as the Presiding Director. This position is
extremely important in governance structure as the Presiding Director has broad authority over
governance of the Board. His responsibilities include: 1) presiding over Board meeting when
9 Caterpillar 2015 Annual Meeting Proxy Statement
http://www.caterpillar.com/en/investors/financialInfo/proxy-statement/annual-meeting-proxystatement.html

10 Caterpillar Guidelines on Corporate Governance Issues (as amended by the Board on February 10, 2016),
http://s7d2.scene7.com/is/content/Caterpillar/C10873165

11 Ibid
12 2015 Caterpillar Annual Meeting Proxy Statement
10

Chairman is not available; 2) serving as a liaison between the Chairman and independent
Directors; 3) approving meeting agendas for the Board; 3) authority to call meeting of
independent directors; 5) direct communication with major shareholders; 6) approving meeting
schedules.13
Another important feature of the Board is that all committees, namely, Audit, Compensation and
Human Resources, and Public Policy and Governance are composed entirely of independent
directors. According to Investopedia article, the Compensation and Audit Committees are two
critical board committees that must be made up of independent members. 14 As such, Caterpillar
went even further with the third committee also composed of independent directors. At the same
time, no Director serves in more than one committee, which facilitates avoidance of any conflicts
of interest. This composition ensures Committees independence in important tasks they perform.
This importance becomes crystal clear looking at the nature of these tasks. For example, the most
important task performed by the Compensation and Human Resources Committee is
determination of CEOs and other executives compensations; Audit Committee oversees
financial reporting, while Public Policy and Governance Committee selects Board candidates,
determines Boards size and composition, as well as undertakes officer succession planning.
According to governance experts, stock compensation or ownership can help align directors
interests with those of shareholders.15 Caterpillar is doing just that as almost 50% of Directors
compensation consists of stocks. Target ownership guidelines require directors to own
Caterpillar common stock in the amount of two and one half times their annual compensation. 16
Moreover, Director Edward Rust is the current Chairman of the State Farm Mutual Automobile
Insurance Company which holds 3.54% of Caterpillar shares. Another director, namely, Juan
Gallardo, is also one of the major individual shareholders of Caterpillar. Thus, the compensation
structure of the Caterpillars Board of Directors is in line with the existing good practices of
corporate governance.

13 2015 Caterpillar Annual Meeting Proxy Statement

14 Evaluating The Board of Directors, Investopedia, December 10, 2013,
http://www.investopedia.com/articles/analyst/03/111903.asp
15 Judith Burns, Everything You Wanted to Know about Corporate Governance, The Wall Street Journal, October
27, 2003, http://www.wsj.com/articles/SB106676280248746100
162015 Caterpillar Annual Meeting Proxy Statement

11

It should be emphasized that since 2000 some shareholders of Caterpillar have been raising
concerns regarding CEOs occupation of the Boards Chair. Generally, it is a very contentious
issue in the world of corporate governance. Many argue that the board of directors should be
totally independent from the management of the company so that the board could effectively
exercise supervision over actions of the executive management. And when the CEO holds
simultaneously the position of the Chair it deprives the Board of its independence and as such,
enables the CEO to manipulate with the Board. That said, many companies do not agree with this
argument and put counterargument that having CEO and chairman of the board as the same
person facilitates communication between the company and the board, and ensures single voice
in dealings with different stakeholders. Skeptics note that both Enron and WorldCom had
nonexecutive chairmen and they worry that splitting the two roles could create conflict in the
boardroom.17 So far, a group of concerned shareholders has failed to gain necessary support for
their proposal of removing the CEO from the Board at the Annual Meetings of Caterpillars
Stockholders.
Who are the major shareholders?

As mentioned above, approximately 63 percent of Caterpillars shares are held by institutions

and banks, 32 percent by individuals and 5 percent by employees through company stock plans.
The major shareholders of Caterpillar include the following individuals18:
Peter Magowan (owns 0.05% of shares) - former managing general partner of the San Francisco
Giants Major League Baseball franchise;
Juan Antonio Gallardo (owns 0.05% of shares) - CEO & Director at Grupo Azucarero Mexico
SA de CV (cane sugar processing, refining and marketing);
Juan Gallardo Thurlow (owns 0.05% of shares) director at Caterpillar Board of Directors,
Chairman of the Board and CEO of Organizacin Cultiba, S.A.B. de C.V., the holding company
for Grupo GEPP S.A.P.I. de C.V. (Pepsicola bottling group in Mexico) and Grupo Azucarero
Mexico, S.A. de C.V. (sugar mills);
Douglas Oberhelman (owns 0.04% of shares) - current CEO and Chair of the Board of Directors
of Caterpillar;

17 Judith Burns, op. cit.

18 Factiva Company Report for Caterpillar 2016
12

 Wunning Steven and Stuart Levenick (0.03% and 0.02% of shares, respectively) both former
Caterpillar executives.
According to NASDAQ.com, there are 1154 institutions that hold shares of Caterpillar.19 Top
Institutional Holders of Caterpillar shares include20:

SSgA Funds Management - 9.89% of shares;

The Vanguard Group, Inc. - 6.32%;
Capital Research & Management Co. (World Investors) - 3.83%;
BlackRock Fund Advisors - 3.69%;
State Farm Investment Management Corp. - 3.57%;
Harris Associates L.P. - 2.94%;
Capital Research & Management Co. (Global Investors) - 2.62%;
Wellington Management Company, LLP - 2.43%;
Bill & Melinda Gates Foundation Trust (Investment Management)- 1.93%;
Franklin Mutual Advisers LLC - 1.38%;
Northern Trust Investments, Inc. - 1.18%;
Mellon Capital Management Corp. - 1.12%.
Top Mutual Fund Holders of shares include21:

Vanguard Total Stock Market Index Fund - 1.88% of shares;

American Funds Income Fund of America - 1.56%
Vanguard 500 Index Fund - 1.24%
Vanguard Institutional Index Fund - 1.09%
Vanguard Wellington Fund - 1.05%
SPDR S&P 500 ETF - 1.02%
SPDR Dow Jones Industrial Average ETF - 0.82%;
Oakmark Fund - 0.76%;
American Funds Washington Mutual Investors - 0.74%;
American Funds Investment Company of America - 0.74%;
American Funds Fundamental Investors - 0.73%;
Vanguard PRIMECAP Fund - 0.71%.
In general, we can say that Caterpillars shares are widely dispersed.
Compensation of top executives

19 Caterpillar, Inc. Ownership Summary, http://www.nasdaq.com/symbol/cat/ownership-summary

20 Factiva Company Report for Caterpillar 2016
21 Ibid.
13

The compensation structure of top executives at Caterpillar contains 4 components: 1) base

salary, 2) stock option, 3) Executive Short Term Incentive Plan (ESTIP), and 4) Strategic
Performance Plan (SPP).22 This compensation structure is heavily linked to the companys
performances. Accordingly, the base salary is the smallest component of the compensation
structure, while equity represents the biggest percentage. Equity has the biggest share as it links
executives compensation to stockholder expectations. These are non-qualified stock options that
expire 10 years after the grant and become exercisable three years from the grant date. Incentive
compensations are tied to performance indicators, as well. They are divided into long-term (SPP)
and short-term (ESTIP) incentives. While ESTIP is based on corporate and business unit
performance, SPP is based on company success in the long-run. In other words, ESTIP is based
on achieving performance goals, especially financial ones, on a business and corporate unit level.
It is linked to earnings per share indicator. SPP, in its turn, is tied to company performance over a
3-year performance cycle and it is mainly about stockholder return measured against other S&P
500 companies.23
In line with abovementioned compensation structure, $14.9 million in compensation of
Caterpillars CEO in 2014 included 1.6 million of base salary, 4 million of ESTIP, 0.9 million of
SPP, and 8.4 million of stock option. 24 So the CEOs compensation structure contained 56%
stock options, 27% of ESTIP, 11% of base salary, and 6% of SPP. For the CFO it was 49% of
stock, 30% of ESTIP, 16% of base salary, and 5% of SPP.25 Furthermore, in order to ensure the
competitiveness of its compensation structure Caterpillar routinely assesses its compensations
against those of other companies chosen by Caterpillar. All these companies are comparable to
Caterpillar in terms of revenue and global presence.
It is interesting to point out that in 2015 the Annual Meeting of Shareholders executive
compensation plan was only supported by 66% percent of stockholders, while this figure was
96% last year.26 This was an indication that shareholders were dissatisfied with the existing gap
between executive compensation and the stock price. Some groups criticized the companys
policy of linking executive compensation to earnings per share which could be manipulated by
22 2015 Caterpillar Annual Meeting Proxy Statement
23 2015 Caterpillar Annual Meeting Proxy Statement
24 Ibid
25 Ibid
26 Shruti Date Singh, A Third of Caterpillar Investors Reject Executive Pay Plan, Bloomberg, June 10, 2015
http://www.bloomberg.com/news/articles/2015-06-10/a-third-of-caterpillar-holders-vote-against-executive-pay-plan

14

share repurchases.27 It should be mentioned that CEOs in the list of S&P 500 companies earned
$12.7 million on average in 2014.28 As such, Caterpillar CEOs compensation with $14.9 million
was above average in 2014 and this represented 14% increase over 2013.29 However, unlike
CEOs compensation, Caterpillars sales have dropped about $10 billion in 2013-2014 and the
stock has tumbled 19% over 2014.30 That is why executive compensation was backed only by
66% of shareholders in 2015 Annual Meeting. And it should be mentioned that less than 70%
support is considered a strong sign of investor dissatisfaction.31

27 Shruti Date Singh, op. cit.

28 Matt Krantz, Surprise! Women Trump Men on CEO Pay, USA Today, April 30, 2015,
http://americasmarkets.usatoday.com/2015/04/30/surprise-women-trump-men-on-ceo-pay/
29 James R.Hagerty and Joann S. Lublin, Shareholders Rebuke Caterpillar Over Executive Pay, The Wall Street
Journal, June 10, 2015, http://www.wsj.com/articles/caterpillar-executive-pay-plans-to-be-put-to-shareholder-test1433942147
30 Shruti Date Singh, op. cit.
31 James R.Hagerty and Joann S. Lublin, op.cit.

15

Dividend Policy

Caterpillar Inc.

2015

2014

2013

2012

2011

Dividends per Share

3.01

2.70

2.32

2.02

1.82

1,788.84

1,666.44

1,496.86

1,319.00

1,176.00

Total Cash Common

Dividends

*dollars in million except per share data

Caterpillar Inc. follows a stable dividend policy. The companys declared dividend increased
every year in a stable manner. Thus, dividend declared was not dependent on the residual internal
funds after projects the company had to spare from year to year. If that were the case, we would
see unstable fluctuation in the dividends declared, especially when looking at a 5-year horizon.
Given how stable the data is from one year to the next in its steady increase, we can also see that
the company is not following a hybrid policy model. Although the hybrid model would show less
fluctuation than the residual model, it would be nonetheless dependent, at least in part, on the
companys yearly profit, and therefore would also see some degree of fluctuation as the company
did not generate stable profit from 2011 to 2015. In fact, profits dropped from $5,681M in 2012
to $3,789M in 2013.
The benefits of using the stable policy model resides in the signals it sends to the market. By
providing steady dividends, the company prevents sending negative signals to the market. For
example, relying on yearly profits to establish dividends translates in a negative signal to
investors every time the company chooses not to pay dividend. Investors may quickly have the
impression that the company is in financial trouble, therefore it is best for them to sell their stock
before the stock price drops. By doing so, the value of the stocks and the firm are jeopardized
every time there is a negative change in the dividend payout.
On the other hand, keeping a stable dividend policy reassures investors. Following the reverse
logic of the previous paragraph, the average investors would not be discouraged from investing
since the company, at least at first sight when looking at dividends only, appears to be in good
16

shape by not sending negative signals. Of course, more details, such as profits, can be found on
financial statements. However, even for investors looking further into company data, they would
at least be reassured that, if their goal is to receive dividend, they can expect that dividend will be
steady.
However, major stockholders and board members may feel nervous about this type of policy. The
industry has experienced a hit in recent years and declaring dividends when profits are
decreasing means the company has less cash flow available for new projects or unexpected
expenses. Consequently, from a major stockholders point of view, this type of policy may
endanger the companys ability to respond to or survive negative trends in the market.
Capital Structure
As we learned in class, capital structure is the mix of debt and equity that is used in order to
finance the organizations assets. The optimal mix of debt and equity should maximize the
stocks intrinsic value and minimize the WACC.32 Organizations typically have a target capital
structure and it can be modified depending the market conditions. In the case of Caterpillar, prior
to the economic recession in 2008, they had a capital structure of 89% debt and 11% equity. 33
This percentage of debt was quite high which can create two issues. The first is that a high
percentage of debt can increase the organizations risk which makes debt and equity more costly.
The second issue is that if an organization enters into financial hardship, they may not have
sufficient operating income to cover the interest which may result in bankruptcy. When the
global economic recession hit in 2008, Caterpillar felt the impacts of reduced sales in early 2009.
As a result, the management team made a conscious decision to lower its working capital, reduce
overhead costs and pay down its debt. By 2012, the organization reduced its debt percentage to
75%. The company maintained their A bond rating.
The current capital structure of Caterpillar is 77.68% debt and 22.32% equity which represents a
debt to equity ratio of approximately 8:2. We would not consider this capital structure as risky
given that Caterpillar has sufficient revenue to cover its interest expenses. More specifically, the
annual interest coverage ratio is 8 which is very strong and indicates that the company has
sufficient revenue to cover its interest on debt at least on a short term perspective. When
32 Brigham, E., Houston, J. Fundamentals of Financial Management. pg. 454
33 Brigham, E., Houston, J. Fundamentals of Financial Management. pg. 452
17

examining the interest coverage ratio on a quarterly basis over the last year however, there has
been a steady decline in this ratio.

Dec 31, 2015

Sept 30, 2015

June 30, 2015

March 31, 2015

-0.07

5.08

8.94

13.05

Annual Interest

2014

2013

2012

2011

Coverage Ratio

11.94

12.22

19.04

19.81

Quarterly Interest
Coverage Ratio

By comparing these ratios to Caterpillars main competitors, we also see that this organization
has a stable capital structure. The table below outlines the capital structure and interest coverage
ratio of Caterpillar, Deere & Company and CNH Industrial:

Company

Capital Structure
Debt

Interest Coverage
Ratio (Annual)

Equity

Caterpillar

77.68%

22.32%

Deere & Company

86.62%

13.18%

5.1

CNH Industrial

87.00%

13.00%

1.5

The capital structure of all three companies are quite similar with Caterpillar having slightly less
debt and more equity. This is most likely as a result of their decision taken in 2009 to reduce
their debt based on the economic recession. Deere & Company also has a very strong interest
coverage ratio at 5.1 which indicates they have sufficient revenue to cover their interest. In the
case of CNH Industrial, their interest coverage ratio is very low at 1.5 which may limit the
possibility of taking on additional debt as lenders may perceive the company as being too risky
and the possibility of default too high. Overall Caterpillars capital structure appears strong and
more importantly they recognize the need to adjust this structure based on market conditions.

18

Cost of Capital
Calculating the cost of capital for Caterpillar provides an indication of how the market views the
risk of Caterpillars assets. Knowing their cost of capital can also help us determine our required
return for capital budgeting projects.
Cost of debt

We start by calculating the cost of debt for Caterpillar by adding up the yield to maturity for
Caterpillar plus the flotation cost. Based on data collected from Bloomberg, Caterpillar does not
list a flotation cost, therefore we used a value of 0 for it. The data from Bloomberg indicated that
Caterpillars combined YTM was 1.77%. Using the formula Cost of debt = Yield to maturity +
flotation cost, we arrive to a before tax cost of debt of 1.77%, and an after tax cost of debt of
1.31% at a 26% tax rate (from Bloomberg). Bloomberg lists the before-tax cost of debt as 1.76%.
This cost of debt is the required return on Caterpillars long term debt.
Cost of equity

Next we calculated the cost of equity for Caterpillar using two methods. The first method is the
Dividend growth method. Using this method we calculate the cost of equity by dividing the value
of dividend for 2015 in 2014 by the share price, and multiplying the result by the growth. We
used the formula Cost of common equity = ((divided in year 1)/price) + growth. The growth rate
was calculated by using FV = PV(1 + g)^n, which resulted in a result of 6.34%. Caterpillar had a
dividend of $2.94 in 2015, which works to $3.13 of value in 2014. The share price as of
December 31, 2015 was $67.69. As mentioned earlier, flotation costs were assumed to be 0.
Plugging these values into the formula results in a cost of equity of 10.94%.
Using the second method which is the Capital Asset Pricing Model (CAPM), which is calculated
using this formula: Cost of common equity = Risk-free rate + Beta*(Market risk premium) = Rf
+ Beta*(Rm - Rf). We risk free rate was 1.77% based on the US department of Treasury 10 year
bond rate34, with a market risk premium of 5.5%. We also found Beta to be 1.60. Plugging these
values in the formula results in a cost of equity of 10.57%.

34 https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?
data=yield

19

Using both methods resulted in similar results for cost of equity, and both results were very close
to the Cost of equity listed in Bloomberg as 10.92%. Cost of equity indicates the return required
by equity investors given the risk of the cash flows from Caterpillar.
WACC and Beta

We then proceeded to calculate WACC by using this formula: WACC = (weight of common
equity*cost of common equity) + (weight of preferred equity*cost of preferred equity) + (weight
of long-term debt*cost of long-term debt). We calculated the ratios/weight of common equity,
preferred equity, and long term debt as 52.5%, 0%, and 47.5% respectively. Note that Caterpillar
does not issue any prefered shares based on Bloomberg data. WACC was also calculated based
on the cost of common equity calculated by both the Dividend growth model (10.94%) and the
CAPM method (10.57%). Plugging these values into the formula, results in a WACC value of
6.338% when using cost of equity of 10.94%, and 6.15 when using 10.57%. Again both WACC
values are very similar. WACC listed in Bloomberg was also very similar at a value of 6.43%.
WACC indicates the average cost of capital for Caterpillar. This average is the required return on
Caterpillars assets based on the market perception of the risk of those assets.
The table below indicates a summary of the calculated Cost of Equity, Cost of Debt, WACC
using both methods, and Beta for Caterpillar. Note that Beta was acquired from Bloomberg data,
and was not calculated specifically.

Results

Value

Cost of Equity Using Dividend Growth Model

10.94%

Cost of Equity Using CAPM

10.57%

Cost of Debt

1.77%

WACC using dividend growth model

6.338%

WACC using CAPM

6.15%

Beta

1.6

Valuation and Stock Price Determination

20

Based on Caterpillars previous income and balance statements taken from Bloomberg, we were
able to produce the following assumptions.
WACC
Long term Growth Rate
Sales growth 2016-2017
Sales Growth 2018-2020
Sales Growth after 2020
Current assets/Sales
Other assets/Sales
Current liabilities/Sales
Net fixed assets/Sales
Costs of goods sold/Sales
SGA/Sales
Nonoperation Income/Sales
Depreciation rate
Interest rate on debt
Interest earned on cash balances
Tax rate
Dividend payout ratio
Loans are repaid at

6.38%
5%
-5%
1%
3%
58%
52%
50%
29%
68%
14%
1%
10%
5%
2%
27%
42%
1000.0 (US
millions)

It is important to note that we used rates over five years (2011-2015) to arrive at our
assumptions. The only exception is sales growth. Here we did not include growth rate of 2011
over 2010, because this growth rate represented an outlier. It was so high that it could have easily
spoiled all of our calculations. For example, without inclusion of 2011 growth rate we arrived at
an assumption of -5%, while with inclusion of this growth rate it was +5%. Therefore, we have
decided against inclusion of 2011 sales growth rate. As such, we arrived at negative 5% as sales
growth rate. Then we consulted different websites and experts, especially Bloomberg regarding
the credibility of our assumption. Fortunately, our assumption was in line with what has been
predicted by Caterpillar itself35 and the industry experts. Our further research has revealed that it
is not reasonable to expect negative sales growth rate after the year of 2017. So based on this
research we have divided our assumptions on sales growth to three parts: -5% for 2016-2017; 1%
for the period of 2018-2020; and 3% after 2020. These assumptions clearly represent the state in
35 Meredith Davis, Caterpillar Forecasts Lower Profit, Sales in 2016, Reuters, October 22, 2015,
http://www.reuters.com/article/us-caterpillar-results-idUSKCN0SG1DK20151023

21

the mining industry with declining commodity prices and the slowdown of the Chinese economy
as one of the biggest markets for Caterpillar, as well as positive expectations after 2018.
To arrive at all other assumptions we used yearly rates over 5 years and then took an average of
those numbers. It is important to note that those yearly rates were not too far from the
assumptions which we arrived at. In other words, there were no outliers which could have
spoiled our calculations. This attests to the credibility of our assumptions.
Last but not least, long term growth rate is based on research conducted by us, while loans
repayment indicator is based on 1% of cash as per Professor Duttas guidance.
The assumptions were used to derive the free cash flow forecasts for the next ten year (20162025). As shown in the table below, the projected cash flows are predicted to decline steadily
over the next decade.
Year
Projected Free
cash flow

2016

2017

2018

2019

2020

2021

2022

2023

2024

2025

4418.7

3643.6

2436.7

2218.7

1974.0

1475.5

1244.9

979.5

675.4

328.3

Next, we calculated the present value of the terminal value. The terminal value calculation is
used to determine the value of the firm for all years beyond which one can reliably project cash
flow using the discounted cash flow. 36
Stage 1 - Calculating the Terminal Value
Weighted average cost of capital, WACC

6.38%

Long-term growth rate of FCFs, g

5.00%

Year 10 FCF (or year 2025)

328.3

Terminal value

24976.5

Present value of the terminal Value

13456.5

The terminal value was then used to help determine total free cash flow for caterpillar in 2025.

Stage 2 - Calculating Total Free Cash Flow (FCF)

36 Wikinvest. (2012). Terminal Value. Retrieved from http://www.wikinvest.com/wiki/Terminal_Value

22

Year
FCF (Free
cash flow)
Terminal

2016

2017

2018

2019

2020

2021

2022

2023

2024

2025

4418.7

3643.6

2436.7

2218.7

1974.0

1475.5

1244.9

979.5

675.4

328.3
13456.5

value
Total FCF

4418.7

3643.6

2436.7

2218.7

1974.0

1475.5

1244.9

979.5

675.4

13784.7

The final step of forecasting involved finding the enterprise value, firm value and per share value
of Caterpillar Inc
Stage 3 - Calculating enterprise value, firm value and per-share value
Enterprise Value
Add in initial (year 0) cash and mkt. securities

22815.3
27906.0

Firm value

50721.3

Subtract out value of firm's debt today

-12748.0

Equity value

37973.3

Per-share equity valuation (based on 582 million shares outstanding)

65.2

Caterpillars Stock price as reported in the stock exchange on March 26, 2016 was $75.25
(USD). Our model revealed a share price of $65.20 US. A comparison of both prices (market
share price and our price would suggest that CAT is currently overvalued. This result could also
indicate that our assumptions are slightly off.
Conclusion

Caterpillars Ratios: Caterpillars liquidity ratios are stable, but worse than its competitors,
Deere and CMI, with a 5-year average of 1.374 for the current ratio. Its asset turnover ratio
showing the companys efficiency, with an average of 0.694, is at the low end compared with its
competitors. Its stability ratios, namely debt to equity, is average when looking at its competitors,
but relatively high with an average of 2.34. The company not only operated a negative growth of

-14.81% in 2015, but also has seen a growth decrease totalling 55% in the last five years.
Corporate Governance: Caterpillars leadership structure reflects existing best practices in
corporate governance. The board is mainly composed of independent directors who ensure true
oversight over managements activities. The only non-independent member of the Board is
current CEO of Caterpillar, and his presence in the Board is balanced by the Presiding Director
23

with broad authority over Boards governance. In line with the existing standards Board
members are shareholders of the company, as part of their compensation is paid in stocks.
Moreover, Audit, Compensation and Governance committees are all composed entirely of
independent directors. Shareholders of the company are mainly institutions, holding almost 63%
of Caterpillars shares, while major individual shareholders also include former and current
executives of the company. Compensation of top executives is closely tied to company
performances. That is why the base salary represents the smallest percentage, while stock option
has the biggest share in compensation structure. Thus, from corporate governance perspective

Caterpillar might look very attractive to investors.

Caterpillars Dividend Policy: Caterpillar follows a stable dividend policy. Despite the
fluctuations and downward trend in the market for the industry, Caterpillar continued to pay out

dividend and even steadily increased through the years, by $1.19 per share in five years.
Caterpillars Cost of Capital: Caterpillar return of debt, which indicates the return on its long
term debt was calculated to be 1.77%. The companys cost of equity which indicates the return
required by equity investors, using the dividend growth method, and the CAPM method, was
10.94% and 10.57% respectively. WACC, which the average cost of capital for Caterpillar, based
on the market perception of risk, was calculated based on the two costs of equity calculations

resulting in WACC values of 6.338% and 6.15% respectively.

Caterpillars Capital Structure: Caterpillars capital structure is 76.68% debt and 22.32%
equity. The company has sufficient revenue to cover its interest with an interest coverage ratio of
8. Caterpillar has a similar capital structure to its competitors and it recognizes the need to adapt

its structure based on market conditions.

Valuation and Stock Price Determination: Caterpillars Stock price as reported in the stock
exchange on March 26, 2016 was $75.25 (USD). Our model revealed a share price of $65.20 US.
A comparison of both prices (market share price and our price) would suggest that CAT is
currently overvalued. This result could also indicate that our assumptions are slightly off.
Overall we would not recommend investing in this company at this time. Although Caterpillar
has a strong corporate governance structure and has been established in the industry for quite
some time, we believe that the current stock price is overvalued. The company is also facing a
decrease in future cash flow which will limit their ability to pay interest expenses given they are
heavily levered. Additionally, when looking at Caterpillars liquidity and asset turnover ratio,
Caterpillars competitors are doing better than they are. The company demonstrated minimal
24

growth in 2015 and their year to year growth has decreased dramatically over the past five years.
For these reasons, we would not recommend investing at this time.

25

APPENDIX A
Detailed background information - Caterpillars Directors
DAVID L. CALHOUN, is the director since 2011 and serves as Senior Managing Director and
Head of Private Equity Portfolio Operations of The Blackstone Group L.P. (private equity firm).
He is also the Executive Chairman of the Board of The Nielsen Company B.V (marketing and
media information). He is also the director at The Boeing Company.
DANIEL M. DICKINSON, director since 2006, is currently Managing Partner of HCI Equity
Partners (private equity investment) holds director position there, too.
JUAN GALLARDO is the director since 1998. He is currently Chairman of the Board and CEO
of Organizacin Cultiba, S.A.B. de C.V., the holding company for Grupo GEPP S.A.P.I. de C.V.
(Pepsicola bottling group in Mexico) and Grupo Azucarero Mexico, S.A. de C.V. (sugar mills).
He also serves as a director in Grupo Financiero Santander S.A.B. de C.V. and Lafarge SA.
JESSE J. GREENE, JR., being director since 2011, professor of corporate governance and risk
management at Columbia Business School in New York City. He previously held an executive
position in International Business Machines Corporation (computer and office equipment).
JON M. HUNTSMAN, JR., is former United States Ambassador to China (2009-2011) and
former governor of Utah (2005-2009), who also serves as a director at Chevron Corporation,
Ford Motor Company and Hilton Worldwide.
DENNIS A. MUILENBURG, director since 2011, is the President and Chief Executive Officer
of The Boeing Company (aerospace/defense products and services) since July 2015.
DOUGLAS R. OBERHELMAN, director since 2010, is currently Chairman and Chief
Executive Officer of Caterpillar Inc. He also sits as a director at Exxon Mobil Corporation.
26

WILLIAM A. OSBORN, director since 2000, comes from Northern Trust Corporation and
holds directorship position at Abbott and General Dynamics Corporation, too.
EDWARD B. RUST, JR., director since 2003, is currently Chairman of State Farm Mutual
Automobile Insurance Company (insurance). Also serves a s a director at Helmerich & Payne,
Inc. and McGraw-Hill Financial, Inc.
DEBRA L. REED, director since 2015, is CEO and the Chairman of the Board of Directors of
Sempra Energy (energy services holding company). She holds directorship at Halliburton Co.,
too.
SUSAN C. SCHWAB, director 2009, former US Trade Representative, is currently a Professor
at the University of Maryland School of Public Policy and a Strategic Advisor for Mayer Brown
LLP.. She serves as a director at FedEx Corporation, Marriott International Inc. and The Boeing
Company, as well.
MILES D. WHITE, director since 2011, is currently Chairman and Chief Executive Officer of
Abbott (pharmaceutical and medical products). He also serves as the director at Abbott and
McDonald's Corporation.

27