Is China Giving Caterpillar and Joy Global Investors Sleepless Nights?

China's importance for the growth trajectories of mining and construction equipment makers is well-pronounced, as the country has the world's largest mining and construction markets. No wonder then that Caterpillar (NYSE: CAT  ) and Joy Global (NYSE: JOY  ) recently made the pilgrimage to Chinese shores. But with the pace of China's economy slowing over the past couple of years, has the growth opportunity dimmed? Let's try and get the complete picture.

The China cherry
China is the ultimate destination for equipment-making companies like Joy and Caterpillar. It is easy to understand why -- the country spent an astounding $1.8 trillion on construction in 2013, nearly $1 trillion more than the U.S. and Japan. According to a Wall Street Journal report, David Phillips of Off-Highway Research has projected that 27% of world's total construction demand comes from China. The government has embarked on an extensive urbanization plan in 2014 to bring 100 million more people to the cities by 2020. The plan entails providing social housing and widening the infrastructure set up, such as rail and air links, and expressways. The government's going to put a jaw-dropping $6.8 trillion into the plan.

Though Joy is purely into mining equipment and lacks the advantage of Caterpillar's diversified portfolio, the bounties in mining, too, are galore in China. U.S. Energy Information Administration puts China at the top of world coal production and consumption, using almost half of the planet's pool. The mining industry is growing at 12.4% annually, with revenue from the coal industry expected to rise 7% to $543 billion in the current year.

A coal shipment under way in China. Source: Wikimedia Commons

These numbers hold water in spite of the slowing economy -- from 7.7% in the fourth quarter of 2012 to 7.4% in the first quarter of 2014. This explains why Cat and Joy have placed their bets high on the juggernaut. In 2009, Caterpillar had eight factories in China -- the number now stands at 26. Joy has seven mining machinery manufacturing factories and one surface mining unit in the country.

The China challenge
Being an emerging economy, China's is a complex market and cementing a foothold has been rather difficult for Cat. Though it came to China decades back in 1978, it's struggled for market share. Cat's market share stood at just 6.3% in 2013, up from 3% in the first quarter of 2012.

Moreover, native equipment makers are posing tough competition as they offer cheaper products, and are even improving on quality. A study shows that the local mining and quarry machinery industry will see an average growth rate of about 22% through 2017. Joy CEO Edward Doheny hit the nail on the head in his March interview to WSJ, saying, "The Chinese have a cost structure right now that we can only dream of. We wake up every day and worry that they are going to be working harder than we are."

Recently mining and oil behemoths have also started warming up to local manufacturers. Rio Tinto has increased its purchases of heavy equipment from the local makers, and so has Royal Dutch Shell. They are moving toward cheaper machinery as they want to rein in costs in a difficult business environment.

Shopping spree
To take on the competition both Cat and Joy have been acquiring local Chinese companies that will help them penetrate deeper into the Chinese market and gain greater acceptability.

Dohney says, "We have to win in China. We have to look like a Chinese company." In 2011, Joy took over a local manufacturer in China, International Mining Machinery, for $1.4 billion to better compete with the domestic products.

Cat followed suit, acquiring Zhengzhou Siwei for $886 million in 2012. Cat's CEO Douglas Oberhelman had said in 2010 that they are on a China offensive, and the buyout was in line with the aggressive stand. It's another story that the deal went sour as Cat came across "accounting misconduct" and had to write down $558 million in 2013.

While for Cat the timing of its expansions and acquisitions has often been a topic of debate, there's no doubt that its sales performance and market share are finally showing some signs of improvements. In 2013, the company grew its sales in the country to $3.5 billion, a good 20% more compared with the past year. Its share in the excavators market improved to 9% in 2013. Cat's new addition Siwei, which makes hydraulic supports for mine roofs, will further help the bellwether in its China endeavors.

Joy, too, is beginning to reap the benefits. In 2013, the company launched five new machines for the Chinese market, synching its technology with the products of the acquired company.

The takeaway
China is one of the biggest opportunities for equipment makers in spite of its slowing GDP. It makes perfect sense for Cat and Joy to give it so much importance. Having said that, it is not easy to gain a bigger foothold in the country as competition from within is quite strong and the market is complex. The U.S. companies are trying hard and are quite optimistic. Let's hope their efforts keep adding to the top and bottom lines.

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8/28/2015 4:00 PM
CAT $75.95 Up +0.29 +0.38%
Caterpillar, Inc. CAPS Rating: ***
JOY $24.01 Down -0.30 -1.23%
Joy Global, Inc. CAPS Rating: ****