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Will Trouble in China Sink Equipment Makers?

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China's double-digit growth has fueled a bonanza in infrastructure development. Hundreds of millions of people flocking to fast-growing cities need housing, roads, and power, all of which is dependent on heavy equipment pulling resources like coal, metals, and building materials out of the ground. This market is dominated by domestic Chinese manufacturers, but foreign competitors like American companies Caterpillar (NYSE: CAT  ) and Joy Global (NYSE: JOY  ) , and Japan's Komatsu (NASDAQOTH: KMTUY  ) have rushed to enter the market, adding capacity and churning out new machines. When Chinese growth fell to its lowest level in a decade this year, demand collapsed and tens of thousands of these machines are sitting unsold and idle.

David Phillips, managing director of consulting firm Off-Highway Research, gave an interview with Bloomberg in which he claimed that construction companies had built twice as much production capacity in China alone as would be needed to meet demand worldwide. Where previously many Western firms didn't even have the inventory to meet Chinese demand, overproduction in the country has become so rampant that this fall, Caterpillar began exporting unsold equipment made in China to the Middle East and Africa.

Phillips projects that from 25% demand growth over the past decade, demand will fall to just 5% over the next few years. Mining companies like Rio Tinto (NYSE: RIO  ) have scaled back on expenditures in China as the government has stalled spending on infrastructure, dropping GDP growth from over 10% for most of the past decade to 7.8%. But is all this bad news really a problem? Or an opportunity?

Diamond in the rough
There's reason to be optimistic. While the slowdown in China has been dramatic, growth next year is projected to be over 8% and remain above that level. Eight percent is a bit lower than China's used to, but it's still quite a fast clip compared to the West. At an investors' conference last month,
Ian Bauert, the head of Rio Tinto's China operations, asserted that even in a sub-8% growth environment, "large volumes of iron ore, coking coal, copper, bauxite, and so on, will still be required." Bauert is confident that as China seeks to move hundreds of millions more people out of poverty, mining and construction equipment will be a necessity, despite this year's slump.

The smart money may just be looking at this slump as a golden buying opportunity. General Electric (NYSE: GE  ) , for instance, has been rapidly bulking up its industrial portfolio, tripling the size of its oil and gas business to $15 billion over the past five years. Now the industrial giant has similar plans for the mining industry, with a goal of growing a $2 billion mining business into at least a $5 billion business "over the next few years." GE has lots of great companies selling at depressed prices to choose from.

There's little doubt that over the next decade or more, we will have more infrastructure, bigger cities, and higher energy needs than we have now, and equipment makers like Joy and Caterpillar will provide the tools for the job. The supply glut in China, as well as a more uncertain economic outlook, are just temporary. Prices have been beaten down too far for some of the world's premier equipment companies, resulting in some great buys today.

Caterpillar is the market share leader in an industry in which size matters, and its quality products, extensive service network, and unparalleled brand strength combine to give it solid competitive advantages. To help you decide whether Cat has earned a place in your portfolio, The Motley Fool has compiled a premium research report, outlining the risks and opportunities the company faces. Best of all, our premium report comes with a full year of analyst updates so you won't miss a beat. Just click here to access it now.

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Related Tickers

10/27/2016 4:00 PM
CAT $83.01 Down -1.12 -1.33%
Caterpillar CAPS Rating: ***
GE $28.63 Down -0.24 -0.83%
General Electric CAPS Rating: ****
JOY $27.90 Up +0.05 +0.18%
Joy Global CAPS Rating: ***
RIO $34.24 Up +0.03 +0.09%
Rio Tinto CAPS Rating: ***