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Message: The Chinese are Coming & Aiming to bury the Competition.
Aiming To Bury The Competition
Chinese competition is coming to Caterpillar (NYSE:CAT - News), Komatsu (OTCPK:KMTUY), Joy Global (NASDAQ:JOYG - News) and other construction and mining equipment makers.
Chinese companies made a big splash at ConExpo, the construction industry exhibition in Las Vegas in March.
"Their message was clear: They are here to stay, and (plan) to further go global," said Citigroup analyst Natalia Mamaeva. She says Chinese firms such as Zoomlion, Liugong Machinery , XCMG, Shantui Construction, Sany Heavy Equipment, and Lishide Construction Machinery aim to grab 20% of industry sales outside of China.
It'll be tough for Chinese construction gear makers to make inroads into the U.S., where they lack dealer networks and service operations, analysts say. However, demand for mining equipment has surged in emerging markets, including Africa, Latin America and the Middle East, driven by higher prices for metals and other commodities.
Chinese companies are projected to gain share initially in construction equipment, such as cranes, excavators and concrete machinery. They'll become a force in mining equipment within 3 to 5 years, analysts say.
1. Business
Caterpillar, Komatsu and others build earth-moving machinery; excavators and cranes; underground mining equipment; and road-building gear.
Mining trucks cost around $1 million to $5 million. Hydraulic excavators fetch $5 million to $15 million. The massive electric shovels used in the mining trade are $15 million to $35 million.
The largest equipment makers have financial service subsidiaries that provide loans to dealers as well as customers, says Standard & Poor's analyst Michael Jaffe. Caterpillar's financing arm, with $29 billion in assets, provided 10% of the company's $2.7 billion in profits last year.
If customers don't repay loans, big machines get repossessed and auctioned off at Ritchie Bros. or IronPlanet, says Frank Manfredi, principal of consultancy Manfredi & Associates.
Equipment demand is cyclical. Caterpillar's sales rose 18% from 2004 to 2008 but fell 37% in 2009 after commodities and the global credit markets collapsed. Sales bounced back 31% last year.
Because earthmovers and mining equipment are so expensive, customers often delay replacing aging equipment. Instead, they pay to maintain older gear. That has made replacement parts a profit center for many equipment makers.
But, as in any business, less downtime for routine maintenance means more production.
S&P's Jaffe says when customers do shop for new equipment, they'll generally pay more for quality tools less likely to have breakdowns.
That helps dealer networks rake in profits, both from sales and from service operations. Peter Holt, whose family controls the largest U.S. Caterpillar dealership, in Texas, owns basketball's San Antonio Spurs.
• Name of the game: As competition with Chinese companies heats up, quality control and reliability will be key, says Ted Grace, an analyst at Susquehanna Financial Group. He says Caterpillar and other gear suppliers can set themselves apart from Chinese rivals with parts and service operations.
"Caterpillar can deliver 98% of its parts within 24 hours," he said. "CAT's dealer support can't be replicated."
2. Market
U.S. construction spending has yet to recover from the 2008 housing market bust. Nonresidential construction on offices and commercial projects is still weak. Government spending on highways and public projects has firmed up, but is a smaller part of the U.S. market.
"Construction is growing solidly in emerging markets, " said Jaffe. "There are big infrastructure build-outs, and these economies are being industrialized."
Emerging markets have accounted for 40% to 50% of recent annual revenue growth for Caterpillar, says Grace. In 2010, Caterpillar garnered only 37.8% of sales from North America compared with 52.9% in 2006.
China, which has huge infrastructure projects under way, alone accounted for 20% of Komatsu's $15.4 billion in 2010 sales, says Nomura.
Capital spending by mining companies such as BHP Billiton (NYSE:BHP - News), Rio Tinto (NYSE:RIO - News) and Xstrata has soared. They've upped purchases of mining equipment to dig for iron ore, aluminum, copper, coal and other raw materials.
In addition, widespread flooding in Australia's Queensland mining district in the fourth and first quarters damaged or destroyed vast fleets of mining equipment, which require replacement or repair.
Mining firms will spend $87.5 billion globally on projects in 2011, estimates Morgan Stanley, up from $30.3 billion in 2007.
Caterpillar, Komatsu and others operate as global conglomerates, diversified across many countries. Commodity and construction markets often rise and fall alternately. As demand in one region tumbles, a boom in another region rises to create equipment demand.
3. Climate
Takeovers exerted a powerful influence on the industry's competitive landscape over the past year .
In late 2009, Bucyrus International acquired Terex 's (NYSE:TEX - News) mining business for $1.6 billion, the largest mining equipment acquisition to date.
Caterpillar upped the ante in November, agreeing to buy Bucyrus for $8.6 billion.
Mining equipment was $4.3 billion of Caterpillar's $40.2 billion in machinery and equipment sales in 2010. Bucyrus, which makes surface mining equipment including draglines and electric shovels, saw $3.7 billion in total revenue.
The combination, which still needs regulatory approval, is placing pressure on Joy Global, analysts say.
Milwaukee, Wis.-based Joy Global is a leader in electric mining shovels. But, the company may need to expand into hydraulic shovels, analysts say, which could lead to another deal.
Both Caterpillar and Terex have eyed Europe's gear makers. EU regulators are looking into Caterpillar's deal to buy German firm MWM Holding. Terex in early May launched a hostile bid for Germany's Demag Cranes.
Komatsu has been on the sidelines as rivals target the mining sector. Citigroup analyst Graeme McDonald doesn't see the Japan-based heavyweight as poised to make an acquisition.
Manfredi disagrees. He says Komatsu could make an offer for Joy Global or buy smaller companies to bolster its mining gear catalog.
Chinese companies, meanwhile, have been taking advantage of their country's unquenchable demand for construction equipment.
Although foreign suppliers are growing sales in China, domestic gear makers still produce more than 80% of construction gear sold there, says JPMorgan analyst Ann Duignan.
Duignan cites XCMG's reported output of 1,400 cranes per month vs. 3,000 cranes built each year by U.S.-based Manitowoc (NYSE:MTW - News).
Such manufacturing scale gives Chinese firms a pricing advantage, she says. To gain market share, Chinese equipment suppliers plan to undercut pricing by at least 10%, analysts say.
Susquehanna's Grace says Chinese equipment firms are developing financing arms in both emerging and developed markets. In March, Liugong partnered with Holland-based De Lage Landen Financial to offer financing in North America.
Sany is building a U.S. headquarters in Peachtree City, Ga. Zoomlion entered the U.S. market in 2007 and plans to open an assembly plant in Milwaukee, Wis.— sacred ground to both Bucyrus and Joy Global.
Manfredi says Chinese firms lack the after-sales parts and maintenance support demanded by customers in the U.S. and Europe.
A smart move, he says, would be for Chinese firms to buy a U.S. rental company. After-sales support are less of a factor in rental markets, he says.
Caterpillar, meanwhile, is fighting back on the home turf of Chinese companies, analysts say. Caterpillar acquired Shandong SEM Machinery in 2008, and aims to sell under the SEM brand in emerging markets.
4. Technology
Work at job sites can grind to a halt if machinery breaks down. So keeping them up and running is key.
"More up-time is a combination of better engineering, better design and (parts) support," said Grace.
Jaffe says research and development is focused on reducing the complexity of machinery by minimizing the number of parts used in assembling equipment.
In the mining industry, Grace says GPS technology is being used to increase productivity at work sites. Komatsu is a leader in "autonomous haulage" in which drivers are replaced by computer- and robotics-controlled machinery.
In the U.S. and Europe, tough diesel emissions standards are an obstacle to Chinese companies, says Manfredi. While Chinese-made engines may be dirtier than those made in the U.S., they'll still pass standards in most emerging markets, he says.
Fuel economy is important, too. Most manufacturers are developing diesel/hybrid electric machinery, such as excavators, that use batteries to store energy, says Manfredi.
5. Outlook
Japan's tragic earthquake and tsunami will create demand for construction equipment as the nation rebuilds. Komatsu, Hitachi Construction Machinery and other domestic suppliers will likely win the most business, analysts say.
• Upside: A weaker dollar gives U.S. equipment a price advantage in international markets. In the first quarter, Caterpillar reported a gain of $94 million due to such pricing-related "currency impacts."
• Risks: A slowdown in China's economic growth would crimp demand for metal and energy commodities and reduce capital spending by mining companies. Internet-based price competition could lower profit margins.
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