Caterpillar and the ERA Acquisition - What Does China Hold in Store?
Muhammad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Despite the slowdown in growth of China’s economy, Caterpillar (NYSE: CAT) still exhibits a lot of enthusiasm with regard to the ERA acquisition. Its enthusiasm is not at all wavered by concerns of the high cost of infrastructure. This suggests that the machinery big wig has spotted a comfortable nesting in ERA. Although, details of its interests in ERA hit the headlines late last year, November to be exact, meaningful progression was made just the other day. This was after the Ministry of Commerce in China gave Caterpillar the green light with regard to the ERA acquisition.
Things as They Appear
As an investor, my main question predominantly revolves around the prospects that China has in store for Caterpillar. After considering the economic setbacks, is China a wise option?
In business, revenue – and in extension profit - is usually maximized through effective and efficient production. Please note that effective and efficient in this context have not been used loosely. Effective as used refers to the production of highly desirable products while efficient refers to using the least possible resources to arrive at highly desirable products. Therefore, to be efficient, you must use the least possible resources, and to be effective, you must maximize on resources or increase resource use all together. It is, therefore, clearly evident that balancing the two crucial elements inevitably places compromise on either. Where does this apply to caterpillar and the ERA acquisition?
It applies in an unimaginable way. Look at it from this point of view. Caterpillar’s presence in China is not all that profound. It still needs to magnify its presence. This is where effectiveness comes in. It needs to familiarize its market with its product and assure them of quality and reliability. This is an undisputed uphill task after considering the cut throat competition that China extends. Nonetheless, if the ERA acquisition pulls through, it will have the upper hand as it will cast its net over a wider market.
One big ‘but’ however looms. How will caterpillar uphold product effectiveness and at the same time cushion detrimental effects on efficiency? For one, providing a balance between the two vital aspects is hard enough. Secondly, even if Caterpillar can provide the much needed balance, the Chinese economy and the global economy is not on its side.
Labor, one of the most crucial inputs, has recorded a dramatic increase in cost. It would be socially incorrect for caterpillar to import its Chinese workforce from its own backyard. It will have to source its labor locally and in the process part with huge amounts of money following the unprecedented increase in labor costs late last year.
It might also be hard for caterpillar to establish a comfortable nesting considering Joy Global's (NYSE: JOY)movements in the Chinese market. Mid last year, Joy secured a stake in a leading underground coal mining equipment designer. The 51.6% stake at International Mining Machinery Holdings gave Joy a gateway into the mining industry. Caterpillar will, therefore, experience a hard time battling Joy which already has notable influence over the mining industry.
The flip side
Every coin has two sides. Caterpillar’s pros in a way wipe out the cons. To start with, caterpillar has revealed its expansion plans in Xuzhou, China. This $100 million project is expected to enhance production of hydraulic excavators by 80% once completed. Although the expansion is still awaiting government approval, expectations are welling as the expansion will exclaim Caterpillar’s name as a leading mining equipment manufacturer.
Doug Oberhelman, the chief executive officer, addressed a press conference and placed profound accents on how the expansion displayed the continued strength in the Chinese market.
This expansion is likely to create the much needed positive vibe. This will not only spell good business for caterpillar but will also create some degree of loyalty in consumers. In the long run, the good effects will balloon and, in the process, boost the prosperity of the ERA acquisition.
Caterpillar also makes sure that it maintains an unquestionable level of top-notch performance all through its fronts. It recently got a 6 year fixed price contract from the Defense Logistics Agency. This is welcome news for stakeholders in China as they are assured of Caterpillar’s aggressiveness and ambition.
As a round up, I believe that Caterpillar’s accelerated operations in China are likely to bear reasonable fruit. It is a good option for the long haul.
muhammadbazil owns shares of Caterpillar. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.