How Will A Weakening China Affect Caterpillar And Joy Global?

Includes: CAT, JOY
by: StockRiters

The latest economic data out of China has once again confirmed the fact that the world's second largest economy is continuing to see a slowdown. This Chinese slowdown is going to hurt US mining and equipment makers like Caterpillar (NYSE: CAT) and Joy Global Inc. (NYSE: JOY) that depend on China for a lot of their business.

PMI Falls to Lowest Level since March 2009

According to data released by HSBC on Monday, an index of China's manufacturing activity, dropped to 47.6 in August from 49.3 in July. This is the lowest reading since March 2009. A reading below 50 means a contraction in overall activity. Meanwhile, official data, released over the weekend, showed that China's PMI dropped to 49.2 in August from 50.1 in July.

Analysts at Bank of America Merrill Lynch said in a research note that it is now getting clearer that China's growth will slow further in the third quarter from 7.6% in the second quarter. Although BoFA-ML analysts expect a soft-landing for China's economy, they believe that growth forecasts for the rest of the year will see some downward revision.

No Sign of Stimulus Yet

Part of China's slowdown can be attributed to measures taken by policymakers to cool down an overheating economy. Some economists argue that as China transitions from an emerging to a middle-income economy, the pace of growth will ease. Indeed, these two factors have had an impact on growth. However, the slowdown cannot be entirely attributed to just these two factors. What has hurt growth even more is the weakness in the euro zone, China's largest trading partner. So it is quite clear that external events have curtailed China's growth recently.

Back in 2008, when faced with a similar situation, Chinese policymakers quickly sprung into action. However, no such urgency has been seen this time around. Chinese policymakers have hinted at implementing measures to stimulate growth, but nothing concrete has been done so far.

It is not clear why Chinese policymakers have been reluctant to stimulate the economy in the wake of the latest slowdown. Inflation, one of policymakers' major concerns, is under control now. Unlike U.S. and the euro zone, China's central bank has room to cut interest rates.

What does a slowdown in China mean for U.S. Construction and Mining Equipment Makers?

U.S. construction and mining equipment makers Caterpillar Inc. and Joy Global Inc. recently gave a gloomy outlook, in large part due to the slowdown in China.

Mike Sutherlin, President and CEO of Joy Global, said last week that while there is evidence that both U.S. and China markets have bottomed out, he expects the recovery to be sluggish. Sutherlin noted that the deceleration of Chinese demand has deteriorated international markets more quickly and severely than previously expected.

The slowdown in China is also having an impact on regions that are commodity exporters, and thus hurting demand for mining equipments. Sutherlin said that he expects to see greater lumpiness in original equipment bookings going forward.

Caterpillar CEO Doug Oberhelman also feels the same. Last month, Oberhelman said that while he expects CAT to have a record year in 2012, he understands the world is facing economic challenges, and if it becomes necessary, the company is prepared to act quickly just as it did in late 2008 and 2009. Oberhelman said that he is cautiously optimistic about the world economy in 2013 even as he remains very positive on the long-term prospects for global growth.

Although CAT raised its profit outlook for 2012 last month, the company has narrowed its outlook range for sales and revenue. CAT now expects full-year revenue to be between $68 billion and $70 billion, compared to its previous forecast of $68 billion to $72 billion.

JOY also lowered its fiscal 2012 revenue guidance. The company now expects revenue for the fiscal year 2012 to be between $5.45 billion and $5.55 billion. Earnings for the full year are expected to be between $7.05 per share and $7.20 per share. JOY's outlook for fiscal 2013 is also gloomy. The company expects 2013 revenue to be flat to slightly down in fiscal 2013.

Should You Buy CAT and JOY

Considering the challenges the two companies face, they do not look like a good bet right now. Both CAT and JOY have underperformed the S&P 500 YTD. While CAT is down more than 5% YTD, JOY has fallen more than 40% YTD.

The fortunes of the two companies will depend to a large extent on how the Chinese economy fares.

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.