The slowdown in the Chinese economy has impacted Caterpillar's (
CAT
) top-line growth year-to-date. Growth has been
particularly hit hard at its Construction Industries division
in China where sales have declined compared to the mid-2011 levels.
The efforts by the Chinese government to cool its rising real
estate prices and control high inflation by maintaining high
interest rates have caused this decline. This is also one of the
primary reasons for the company's stock price decline, which is
down nearly 25% from its peak levels of $115-$116 in February
earlier this year to $86-$90 at present. However, we anticipate the
stock to move upward again as the interest rates in China ease with
lower inflation levels. The country has been a major growth
market for Caterpillar over the past decade and its increasing
urbanization is expected to continue to drive its top-line growth
over the coming years.
In addition, the long-term growth factors for Caterpillar remain
intact as rising world population, prosperity and urbanization will
increase demand for energy and resources, promoting growth across
its industrial businesses: construction, mining and power
systems.
We currently have
a stock price estimate of $97 for the company
, approximately 7% above its current market price.
See our complete analysis of Caterpillar here
The Slowdown in Growth of the Chinese Economy
China's GDP expanded 7.6% year-over-year in the second quarter
of 2012, its lowest in three years and its sixth consecutive
quarterly decline. The slowdown in growth is the result of high
interest rates, which have been maintained in order to control
inflation which exceeded 6% in July last year, well above the
government targeted 4%. Only recently have the inflation levels
eased below 4%, prompting the Chinese central bank to cut its key
lending rate in June. At present, the benchmark lending rate stands
at 6%, which is still very high compared to the rates in the U.S.
and other developed countries. As a result, the consistently high
interest rate regime has impacted the growth of companies operating
in China, particularly in the construction industry.
Companies Reel Under High Interest Rates
Caterpillar witnessed a y-o-y decline in sales for its
construction business division in China in the second quarter. The
division manufactures and sells machinery used in infrastructure
and construction applications. In addition, at the Bank of Amercia
Meryll Lynch New China Conference held in November last year, the
company had indicated that it expects the interest rates in China
to ease in 2012. However, as that did not happen in the first
half of 2012, the company ended up overestimating construction
equipment demand in China, and hence it is now planning to export
the extra inventory in the country to other developing
countries.
Other companies operating in the Chinese construction industry
have also been impacted. Japan's Komatsu Ltd., which is the
second-largest maker of construction equipment in the world after
Caterpillar, reported a 42% decline in its last quarter earnings on
lower sales in China, forcing it to cut its profit outlook by
17%. Sany Heavy Industry Co. Ltd., China's largest
construction equipment manufacturer, also lowered its sales
forecast for 2012.
Lower Inflation Rates Augur Well for Companies
However, inflation rates have now come below the government
targeted 4%. The Consumer Price Index (
CPI
) inflation touched a 30-month low of 1.8% in July. This augurs
well for the industry as People's Bank of China, which is China's
central bank, now has more room for growth revival. And if interest
rates are cut sufficiently, we could see higher sales for
Caterpillar's Construction Industries division in China in 2013,
and a corresponding increase in our price estimate for the
stock.
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