4 Winners (and 1 Loser) as China Regains Its Footing

Howard is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

China watchers have seen a good deal of encouraging news in recent weeks, and since New Year’s Day the reports on the country’s economic state have been the most positive of the lot. A key government measure of the manufacturing sector showed expansion in December for the third straight month. A similar study by HSBC, which concentrates on smaller private manufacturers, said growth hit a 19-month high. Copper — the commodity that most mirrors development and manufacturing activity — surged to its highest level in nearly three months and data from China (as well as the U.S.) led to anticipation of even stronger demand in the new year. Additionally, service sector growth accelerated during December at the fastest pace in four months, further underscoring a year-end revival that is expected to carry over into 2013.

Overall, many observers now believe the Chinese economy will have grown by 8% in 2012, with similar to slightly stronger expansion expected in the coming year. Not the double-digits of a few years back, of course, but still pretty impressive these days. Most surveys that support these projections show government-backed spending on infrastructure improvements have been the single biggest driver of the recovering activity. Firms that supply the “big iron” for construction activity are accordingly seen as top short-term beneficiaries, while transportation companies — still negatively impacted by a weak demand for Chinese exports — will likely remain in a slump.

Four heavy equipment OEMs that could gain

It’s been a tightrope walk for global heavy equipment Original Equipment Manufacturers (OEMs) focused on China in recent months. Mining, which held these firms up when other end markets faltered, has slowed. Domestic competitors keep cranking out dramatically improved machinery at lower prices, and often enjoy an official support that outside firms do not. Still, you can’t minimize the potential impact for everyone when the government of the world’s second-largest economy decrees that it wants more roads, bridges, and housing. Not surprisingly, all the most recently released surveys show the greatest improvement in the non-manufacturing sector has been in construction services.

As the category’s worldwide leader, Caterpillar (NYSE: CAT) stands to see a big upside. Although China is currently responsible for only about 3% of the company’s sales, it has greatly expanded in the country in recent years and now offers a deep portfolio of its own well known, but costly branded products in addition to lower-priced machinery produced in joint ventures with local manufacturers. The former appeals mostly to large operations and the latter to smaller projects, so the trickle down impact of government-backed development should benefit CAT on both ends — and results could be apparent as soon as the company reports 4Q12 earnings on January 28. Likewise, the development of local plants designed to expand its China capacity now could make Deere (NYSE: DE) a winner as well. The world’s largest manufacturer of farm equipment also has a significant construction machinery division and has long planned to leverage its brand in this country. An uptick now would prove a pleasant surprise, as company officials said in their last earnings report that they expect little China improvement in 2013.

Hitachi (NASDAQOTH: HTHIY) and Komatsu (NASDAQOTH: KMTUY) are also potential short-term winners, although both face challenges because of an ongoing territorial dispute that has led to Japanese product boycotts in China. Most protests thus far have been aimed at consumer products like automobiles, however, so construction machinery may escape relatively unharmed. Komatsu, the world’s second-largest heavy equipment firm, has traditionally led even CAT in sales of large excavators in China and is very strong in several other categories. Hitachi is particularly well received in the smaller, under 20-ton excavator market, where it is seen as a bigger player than almost all global and domestic brands. Projecting similar images, appealing to similar customers and associated with similar prices and quality, both companies are viewed positively by the Chinese construction industry.

One transportation company that could be hurt

Many of the new surveys that project construction industry strength also cite ongoing weakness in the transportation space. If that pans out, Cummins (NYSE: CMI) could take another big hit. The company’s China engine demand first took a turn for the worse in late 2011, when red-hot heavy-duty truck sales collapsed as a result of the slowing economy and government regulations to limit vehicle emissions, reduce fuel consumption, and fight inflation. CMI had been realizing about 30% of its sales from emerging markets and projecting even larger gains from China that would be achieved through significant increases in production capacity at its two major joint ventures with domestic manufacturers. The subsequent fall was hard and recovery has been elusive, as was evident in October when the company lowered its 2012 guidance largely because of the continuing slowdown in China engine sales. CMI reports 4Q12 earnings on January 28 and the results from Asia will not likely show improvement.

Conclusion

As with most things concerning business in China, visibility is usually cloudy and numbers often suspect. However, the sheer number of similar, positive reports that have appeared since the first of the year is encouraging, as is the almost unanimous contention among them that infrastructure development will be ramping up in 2013 and the construction industry will benefit. The first real proof may come as soon as late January when CAT reports.


TheChiefToo has no position in any stocks mentioned. The Motley Fool recommends Cummins. The Motley Fool owns shares of Cummins. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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