By CMR Senior Analyst Ben Cavender
American construction machinery bellwether Caterpillar (CAT) has had a tough year. Its stock price is languishing in the high 30s down from a 52 week high of 85.96 and it has drastically reduced its full time and part time workforce. Given the state of the global economy and the slack demand for construction projects this comes as no surprise.
The US still has a glut of excess housing and it looks like 2009 is shaping up to be the worst year for housing starts in more than 60 years. The US stimulus plan is not emphasizing infrastructure nearly as much as it should or nearly enough to offset the lack of private funding for projects so while demand will rebound it will still be some time in coming.
CAT’s Q1 results reflect the global turmoil as sales decreased 30% in North America. Europe/Africa/Middle East fared even worse seeing sales retreat 46%. Caterpillar’s story is shared by many other construction industry giants as they try to survive what promises to be another slow year. Komatsu, Japan’s number one construction equipment maker, expects profits to be reduced 96% in the first half of the year and in response to weak North American demand Komatsu is planning to close a plant in Mexico. Hitachi, Japan’s number two, may be fairing even worse and is expected to post a loss through the first half of the year.
However, there is hope for CAT and other multinationals like Komatsu (OTCQB:KMTUY) and Terex (TEX). That hope is China. Unlike the US and Japan, China has made investment in infrastructure a cornerstone of its stimulus package and there is ample opportunity for multinational construction equipment makers to balance weak demand in other markets.
With the lion's share of its $586 billion dollar stimulus package targeting development of infrastructure such as roads, rail, ports, and airports, China has managed to give the construction market a soft landing which is the main reason why CAT’s Q1 sales in Asia only declined 2%, doing considerably better than other markets. Another promising sign is that CAT’s Asia region engine sales actually increased 10% in Q1 showing that despite the hit China has taken on exports the fires of its economy are still burning.
To continue to profit in China, CAT is going to have to watch out for other multinational construction firms like Komatsu, but also domestic players who are coming on strong and taking advantage of the downturn to press their position in the market.
Multinationals have faced challenges selling their machinery to Chinese builders because their machines are often considerably more expensive that the domestic alternatives which have competed by giving up profits to build revenue.
The biggest threats may come from domestic construction machinery juggernauts like Xugong Group and companies like Zoomlion and Sany, both of which are intent on becoming increasingly important players both at home and abroad. In an attempt to increase market presence and facilitate expansion into other markets Zoomlion in February acquired Italy based concrete machinery company CIFA signaling firm intent to grow outside of China.
China is a must win market as it will continue to have strong demand for construction equipment but in order for multinationals to compete with fast growing Chinese manufacturers they are going to have to beat Chinese companies at their own game in China.
CAT’s approach was to woo and ultimately acquire a Chinese firm, Shandong SEM Machinery. This allowed it to compete head to head with other domestic manufacturers with a domestic brand and also gain a foothold for the CAT brand at the top end of the market. However, acquisitions don’t always meet with approval from the government. Carlyle Group, a major private equity firm attempted to buy a majority stake in Xugong Group but ultimately failed due to a lack of support from the government.
Acquisitions have potential as a means of gaining a foothold in the China market, but even if they don’t work, multinationals still have a lot of opportunities to benefit from China’s infrastructure development and urbanization trends but they have to get their business model right to be successful.
Because they can’t compete on price multinational brands are going to have to stand apart from both a convenience standpoint, and a quality standpoint. To do this they will have to streamline dealer networks and work with partners that offer better service than the domestic competitors. They will also have to tailor the functions and designs of their products to meet the specific needs of the China market. If multinationals like Caterpillar and Terex can do these things then they will also continue to share in China’s growth.