Lower Chinese August Inflation Is Great News For These Cyclical Companies

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 |  Includes: AGCO, CAT, CMI, DE, JOY
by: David White

China’s August inflation eased slightly to +6.2% from July’s higher +6.5%. This should put further tightening measures on hold for now. There may not be easing in the near future, but “no new tightening” can be looked at as an easing of a kind. If you follow the maxim, “Don’t fight the Fed” (or the PBOC in this case), the light has just turned from RED to YELLOW in China for big US multinationals with a strong presence there. For those US multinationals whose products will actually help China fight inflation, the picture just got rosier.

Raw materials and food are probably the two biggest sources of inflation for China. Food prices in China were up 13.4% year over year in August. Iron ore, bauxite, copper, etc. are the fuel for China’s rapid industrial growth, which was a +9.5% GDP for Q2. China may be trying to cut down on sales of some US companies' products, but it has no choice but to buy the products of other US multinationals. China has to increase its mining if it hopes to cut down on the amount of coal, iron ore, bauxite (aluminum ore), copper, etc. that it imports. It has to buy more and better farming equipment and fertilizers if it hopes to avoid paying higher and higher prices for food. China is already expected to be the biggest coking coal importer by 2015. Huge growth in thermal imports is expected too. It will want to do what it can to ameliorate the damage to its trade balance by mining more itself. It already has huge expansion plans for the Tavan Tolgoi project in Mongolia along with many other expansions and new projects. These will all require machinery.

Some companies have made Chinese buying of their products less painful by manufacturing many of the things they sell to China in China. A few of these companies are Caterpillar Inc. (NYSE:CAT), Cummins Inc. (NYSE:CMI), Joy Global Inc. (JOYG), AGCO Corp. (NYSE:AGCO), and Deere & Company (NYSE:DE). Each of these companies has a substantial manufacturing presence in China (and/or is expanding its presence). CAT and DE have the biggest manufacturing presence there of the five, but then they are the biggest companies. This may also mean that they will be the most positively affected.

This isn’t just true of China sales. India will be a big buyer for the same reasons. Plus there are 43 other Asian countries besides those two behemoths that are forecast to have growth of 7.8%+ in 2011 and 7.7%+ in 2012. Many or all of these will want to buy many of the same products as China and India. This is without even considering the many other emerging economies such as Brazil. Brazil is putting in railroads. It is building infrastructure rampantly to support its rapidly growing economy. It is starting to prepare for the Summer Olympics in Rio de Janeiro in 2016. Once its railroads are in, it will be able to rapidly build its farming industry for export. With some of the greatest water resources and most fertile land in the world, these should be tremendous. This is just one country. The idea that these companies will sell only in the US or Europe or even mostly in those countries is an outdated delusion of people with overly inflated ideas of their own self importance.

These companies are not under any such delusion. They will be successful because they are chasing their business where ever it happens to be. A slowdown in Europe and the US will hurt, but it is by no means their only business. Plus the US and EU business will by no means completely disappear. When you consider all of the new construction business in the US due to the new oil shale fields development (and the infrastructure around them), it is hard to believe there will be a big drop off in US business in the near future. When the President of the US talks about rebuilding roads and bridges in his stimulus package speech, that adds further fuel to the positive story of these companies.

Let’s look at the financial fundamentals of these companies. Some relevant data is in the table below. The data are from TDameritrade and Yahoo Finance.

Stock

CAT

JOYG

CMI

DE

AGCO

Price

$87.04

$81.50

$90.01

$77.26

$42.59

1 yr Analysts’ Target price

$126.40

$105.07

$134.50

$90.33

$58.22

Predicted % Gain

PE

14.40

14.85

11.81

12.72

11.50

FPE

9.47

11.27

8.55

10.61

9.34

Avg. Analysts’ Opinion

2.1

2.3

2.2

1.9

2.4

Miss Or Beat Amount For Last Quarter

-$0.23

+$0.08

+$0.40

+$0.02

+$0.20

EPS % Growth Estimate for 2011

62.90%

35.00%

72.10%

38.40%

76.30%

EPS % Growth Estimate for 2012

35.90%

21.70%

18.30%

12.90%

11.50%

5 yr. EPS Growth Estimate per annum

17.50%

18.53%

12.00%

12.38%

12.50%

Market Cap

$56.23B

$8.57B

$17.35B

$31.98B

$4.11B

Enterprise Value

$81.17B

$9.04B

$16.64B

$54.83B

$4.26B

Beta

1.93

2.12

1.99

1.60

1.90

Total Cash per share (mrq)

$14.64

$4.21

$7.65

$8.14

$5.94

Price/Book

4.28

4.56

3.42

4.36

1.32

Price/Cash Flow

8.92

13.22

9.22

9.44

8.62

Short Interest as a % of Float

2.09%

3.56%

1.91%

2.02%

2.81%

Total Debt/Total Capital (mrq)

71.22%

32.57%

12.12%

77.65%

19.06%

Quick Ratio (mrq)

1.25

1.02

1.31

--

0.89

Interest Coverage (mrq)

17.79

39.12%

--

6.86

16.13

Return on Equity (ttm)

35.44%

38.83%

33.03%

37.92%

13.46%

EPS Growth (mrq)

39.22%

42.57%

108.35%

17.35%

106.74%

EPS Growth (ttm)

146.59%

30.28%

98.96%

120.45%

200.72%

Revenue Growth (mrq)

36.71%

33.69%

44.67%

22.45%

35.32%

Revenue Growth (ttm)

51.05%

19.73%

38.09%

26.79%

26.94%

Annual Dividend Rate

$1.84 (2.10%)

$0.70 (0.80%)

$1.60 (1.80%)

$1.64 (2.10%)

N/A

Gross Profit Margin (ttm)

27.00%

34.16%

24.77%

25.69%

19.51%

Operating Profit Margin (ttm)

11.56%

20.64%

14.07%

12.80%

6.62%

Net Profit Margin (ttm)

8.00%

14.14%

9.99%

8.43%

3.93%

Click to enlarge


All of the above companies look solid. Each is a good investment. AGCO’s Net Profit Margin is so low as to be worrisome, when the US and EU may be heading into recession. However, you cannot fault its profits recently.

Aside from the China inflation signal that “less fettered growth” may be expected in China, many are expecting huge inflows in foreign capital into Asian countries soon. Such a surge might be a pain for the governments overseeing those economies. However, it would be a boon to the companies listed above. More investment in new mining operations, etc. would mean more sales by CAT, JOYG, and CMI especially.

Let’s take a look at the technicals via the two-year charts for these companies.

The two-year chart of CAT is below - (click charts to enlarge):

Click to enlarge

The two-year chart of JOYG is below:

Click to enlarge

The two-year chart of CMI is below:

Click to enlarge

The two-year chart of DE is below:

Click to enlarge

The two-year chart of AGCO is below:

Click to enlarge

The first three of the above charts show a very powerful reverse head and shoulders pattern. The last two show an almost as powerful classic Bollinger Band double bottom pattern. The MACD’s of all of the charts indicate that each is in a strong move upward. The charts themselves indicate that there should be substantially more upside to each move. Hence technically and fundamentally these stocks should rise.

With respect to the overall market, two of the top market strategists, Abby Cohen of Goldman Sachs and Jeffrey Saut of Raymond James, have said that they believe the overall market should rebound substantially this fall (and even possibly in September). Such an overall market move up would provide further fuel for the up moves in the above stocks. Let us hope it comes. However, if you are thinking longer term, you should be able to invest in the above stocks even if we do not immediately get an overall market upturn. The products they have to sell are that needed by the emerging economies. As always legging in is a good strategy in an uncertain market.


Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in CAT, CMI, DE over the next 72 hours.