China Is Still Beneficial For Caterpillar

| About: Caterpillar Inc. (CAT)

Caterpillar (NYSE:CAT), the giant construction equipment maker, is in worse condition due to weak demand for its mining equipments and declining backlog. The company's mining equipment sales, which generated nearly one-third of CAT's total sales in 2012, are declining due to reduction in capital spending by mining companies. It is estimated that mining capital spending will decline 11% in 2013 and 14% in 2014.

Caterpillar's net profit in the second quarter of 2013 was $960 million, down from $1.7 billion a year earlier. Revenue fell 16% to $14.62 billion. The results also reflected a drop in dealer inventory by $1 billion during the quarter. The company's total sales diminished in all regions with fastest fell in the Asia-Pacific region.

Caterpillar is largely dependent on the China market. The company's sales in China, excluding acquisitions, were up 20% year on year in the second of 2013, driven by strong demand for its power system products and construction equipments. Caterpillar is not only the mining sector player, it has a strong hold in the construction business. Due to China's urbanization process, the demand for the company's construction equipment will expand in the future.

China plans to move 400 million people to cities. Over the next decade, the country plans to spend $6.5 trillion on moving people to cities. China will require substantial investments in infrastructure and other kinds of construction that will push the demand for construction products. Caterpillar Controller Mike DeWalt stated that China is continuing to grow despite the doomsayers. He said, "We do not expect the significant economic growth rates that China experienced over the past 10 years will continue indefinitely, but we do believe that China will continue to grow at a much faster pace than the rest of the world."

To accommodate them into cities, China needs to construct new cities (large, mid-sized and small) and towns. Urbanization across China also requires investment in public services as well as public parks and gardens to attract new city dwellers. According to a forecast, China will have 221 cities each with a population of over 1 million by 2025. This expansion will drive demand for construction equipments that will help boost Caterpillar's construction equipment sales in China.

According to Transparency Market Research, the global construction equipment market will reach $192.3 billion by 2017 from $143.6 billion in 2012. China accounted for the majority of the global construction equipment consumption, with Europe at a distant second. The construction equipment market in China is estimated to reach $95.6 billion in 2017 from $59.2 billion in 2012.

Caterpillar has a range of agricultural equipments that are fuel-efficient and reliable. In agricultural machinery segment, Deere & Company (NYSE:DE) is the main competitor of Caterpillar, but Deere has less exposure in the China market than Caterpillar. Worldwide, the demand for agricultural machinery is forecast to grow 6.7% annually through 2016, to nearly $173.5 billion in revenue. Growth will be driven by replacement of older machinery with more technologically advanced equipment and increased mechanization of agriculture in rapidly developing nations predominantly China, Brazil and India.

Agriculture is a vital industry in China as the country ranks first in agricultural output in the world. The Chinese government has an objective to rise its agricultural mechanization from 52% in 2012 to 70% in 2020 and 80% in 2030. Caterpillar holds a strong market share in China and India. Increased mechanization of agriculture in these regions will definitely help Caterpillar to boost its sales.

India will also provide opportunities for the company as the country's economy will grow in the range of 5.5-6.5 percent in 2013. Infrastructure is a major sector that drives overall development of the Indian economy. India is expected to become the third largest construction market in the world by 2025.

Bottom Line

Despite weak mining activity, the long-term future of Caterpillar is still bright. Due to China's urbanization, the company's construction segment will generate significant revenue in the next few years. Caterpillar has a potential to benefit from a recovery in China, that's why I recommend the investors to buy the company's stock at current price and capitalize on it when Caterpillar's share price increases in the future. Short-term investors can also benefit from this company.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.