As I recently lamented in an article on Cummins (NYSE:CMI), U.S. investors don't let quality heavy machinery/industrial names like Cummins or Caterpillar (NYSE:CAT) linger long in value territory. This leaves investors with a few choices - pony up and pay current prices (even if the risk/return tradeoff isn't great), avoid the sector altogether, or go shopping for less traditional names. I'm a fan of that last approach, and just as I think Atlas Copco (OTCPK:ATLKY) is a solid industrial name overlooked because of its thinly-traded ADR listing in the U.S., Komatsu (OTCPK:KMTUY) looks like a name at least worthy of further discussion.
Wait, I've Heard All This Somewhere Before
To be sure, Komatsu isn't posting especially impressive numbers right now. In its most recently reported quarter, Komatsu posted a 5% revenue decline (Caterpillar had 15% organic growth), with mining/construction sales in China down a whopping 46%. With that lower revenue number came worse operating leverage (operating profit down almost 19%) and lower guidance.
If there's good news, it was that mining and construction equipment sales were down less (down 2%), as the company saw slight growth in Japan and high teens growth in the Americas. What's more, volume was better than these numbers suggest, given adverse currency moves. Nevertheless, management revised full-year guidance (ending March 2013) for revenue from 6% growth to a 0.6% contraction, with China expected to be down 25% or so for the year.
Although this is admittedly just one anecdotal piece of information, Komatsu management talked about as many as 40,000 hydraulic shovels potentially sitting in dealer/distributor inventories across China. While that might pinch domestic companies like Sany or Zoomlion harder, it's hardly good news for Komatsu, Caterpillar, or Volvo (OTCPK:VOLVY).
So why should an investor mess with Komatsu - after all isn't it a pain to own a lot of five-letter ADRs? While that used to be true, it has gotten a lot easier to follow companies like Komatsu. Not only do popular financial news sources provide more data than before, but Komatsu offers up a lot of investor information in English. What's more, the shares are plenty liquid for the needs of most investors.
Moreover, this happens to be a quality company. Komatsu is not only the second-largest construction equipment company in the world, but it's quite diverse in terms of where it gets its sales. North America is about 15% of sales (unfortunate for Komatsu, given the growth here today) and Europe is less than 10%, while South America and Japan are about 15% each and China and Asia make up the rest. What's more, the company has already established strong share in many major markets - including mining in Australia and Indonesia and mining and construction in China.
I also happen to like how this company runs itself. Management is rather conservative, and that approach extends not only to its financing and inventory policies (which has in the past led to less bad debt expense and lower inventory levels than rival OEMs), but also capital allocation. Komatsu has declined to pursue an acquisition of Joy Global (NYSE:JOY), for instance, in favor of investing that money in internal product development.
Speaking of which, Komatsu has had legitimate success in innovative technology development. Komatsu claims to have been first to market with hybrid engines for a variety of equipment types (including excavators), and the company had advanced GPS tracking capabilities as standard equipment since 2000. And it doesn't sound as though the company is done - in publicly dismissing rumors of a buyout of Joy Global, management pointed to its intentional to invest heavily in automation for the mining industry; a development that could not only make mining safer, but could offer significant cost savings as well (much of which would accrue to Komatsu in the form of higher prices and/or market share).
So Why Do Analysts See Things So Differently?
One thing that I do find striking about Komatsu is the extent to which analysts are less enthusiastic in their numbers for the company than for American-based comparables like Caterpillar, Cummins, Deere (NYSE:DE) and so forth. A few percentage points of estimated revenue growth in 2015 may not sound like much, but it does add up pretty significantly in DCF models.
There are a lot of similarities between Caterpillar and Komatsu in terms of details like return on capital, asset efficiency, margins, and so on, though Komatsu has less leverage. The differences may be telling though. Caterpillar offers a much more complete array of mining products and equipment and also has substantially larger North American exposure. That latter point is definitely an advantage today (as North American growth is holding up better), but a lot of American Caterpillar analysts see a lot more Asian/Chinese/South American construction and mining industry growth than Komatsu's largely Japan-based analysts. At a minimum, it's something for investors to think over.
The Bottom Line
Am I worried that there is already a glut of construction and mining machinery in emerging markets? I am, but then I'm basically a professional worrier. While I might be more cautious about the risk of disappointing growth in emerging markets over the next three to five years than I was six or 12 months ago, I still think there is considerable potential in the major emerging markets (Brazil, China, Indonesia, India, etc.) over time.
Curiously, even with lower revenue and free cash flow conversion growth estimates relative to Caterpillar, Komatsu still emerges as slightly cheaper. Provided that Komatsu can generate mid single-digit revenue growth out through 2017 (on average) and slightly improved free cash flow margins, these shares look as though they should trade close to $30. For a conservatively-run company with a respect for internal innovation, that's at least enough potential to be worth a closer look.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.