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China's Growth Is a Hotly Debated Topic

By Reuben Gregg Brewer - Mar 15, 2014 at 1:40PM

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The big wild card in the mining industry is China. How fast will the country grow and what does that mean?

Demand from China has been a driving force in the mining industry for quite some time. Over the last few years, however, the country's growth rate has decelerated, and that's left many markets oversupplied. So the big question on every miner's mind is, "How fast will China grow?"

Slowing down
Diversified miner Vale ( VALE -0.97% ) projected Chinese growth of around 7.5% this year when it released fourth quarter earnings. Next year the company is looking for 7%. Over the next couple of years, the country's growth is expected to slowly retreat toward 6%.

Those numbers are predicated on the belief that, "Reforms will probably be implemented smoothly, without major disruptions in any sector." But that's a big wild card. The country has been tightly controlled from the top down for decades, but Vale believes that "the central government wants to let the market play a decisive role in allocating resources."

While moving toward a freer market is good for the long term, it will likely make things "more uncertain in the short term," according to Vale.

(Source: Aspen04)

Watching China's waistline...
Another company keeping an eye on China is PotashCorp ( POT ). A large population moving up the economic ladder spells increased demand for food and, thus, the fertilizers Potash sells. However, according to CEO William Doyle, "incremental domestic capacity gains [in China] have largely kept pace with... rising needs." So demand from China hasn't been particularly robust.

That's why Doyle notes that "the consistency of engagement by key contract markets in the second half will play a pivotal role in determining the extent of the global demand recovery." Basically, demand out of China will be a big determinant of where the fertilizer market goes. Less growth will likely mean less demand. 

...And skyline
In Nucor's ( NUE -1.48% ) fourth quarter conference call, CEO John Ferriola made it clear that global steel production overcapacity is the greatest threat to the steel industry. In the third quarter call, he singled out China as the biggest offender, noting 300 million tons of excess capacity.

While China is closing steel plants, some suggest it isn't doing so fast enough to offset new capacity additions. Wang Jiguang, marketing director at Hebei Iron and Steel Group, recently noted that plant closures so far have been confined to "the smaller, more outdated steel facilities." While it's a good sign that mills are shutting, the way it's happening makes Nucor's concerns all the more real, but that could be good for coal miners.

(Source: Mstyslav Chernov)

Gregory Boyce, CEO of coal giant Peabody Energy ( BTU ), noted, "Globally we saw coal demand reach new highs in 2013. China and India again drove record imports ... China has overtaken Japan as the largest metallurgical coal importer." The country is also continuing to build coal-fired power plants. All of that's great, but if China's growth slows more than expected, Peabody could find that its industry outlook shouldn't have been so bright.

More than just miners
The question of Chinese growth goes beyond the miners, too. For example, Caterpillar's ( CAT -0.97% ) outlook assumes that China's economy will grow slightly more than 7.5% in 2014, similar to the past two years. That would be good for Caterpillar, but, like Value, the company noted that reforms could "impact the economy and the industries we serve."

China's slowdown has been a drag on Caterpillar's results, as overcapacity in the mining industry led to a steep 16% sales drop last year because miners stopped buying as many new machines. In fact, Caterpillar's sales of construction equipment were actually higher year over year in China, but that was more than offset by weakness in the global mining industry.

Miners and mining suppliers are keeping a close eye on China. Although there's still enormous demand in the country, how that filters down to sales is a big wild card. That's especially true as the country looks to loosen its top down controls. If you watch the mining industry, you need to keep a close eye on this giant country's growth prospects.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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Stocks Mentioned

Nutrien Stock Quote
Nutrien
POT
Caterpillar Inc. Stock Quote
Caterpillar Inc.
CAT
$191.47 (-0.97%) $-1.88
Peabody Energy Corporation Stock Quote
Peabody Energy Corporation
BTU
Nucor Corporation Stock Quote
Nucor Corporation
NUE
$104.69 (-1.48%) $-1.57
Vale S.A. Stock Quote
Vale S.A.
VALE
$12.25 (-0.97%) $0.12

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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