The global machinery sector is very complex. It is affected by a variety of cycles — including economic, construction, commodity and replacement cycles — that differ both in their timing and the particular companies they affect.
In fact, the cycles that affect machinery companies are so varied that it’s difficult to make generalizations, says Charles Burbeck, head of global equities at HSBC Halbis Partners in London. Consequently, you have to look at each company individually and, sometimes, look at the geographical mix of sales of the companies within the sector.
Currently, the mining and farm machinery subsectors are doing well, as high commodity prices have increased producers’ demand for more or better equipment. Companies selling construction equipment in emerging markets are also doing well, while those focused on the U.S. are enmeshed in the housing downturn. The truck sector is doing well in Europe, where environmental legislation has led to replacement demand; but it is not doing as well in the U.S., where the environmentally driven truck-replacement cycle is now over.
Peoria, Ill.-based Caterpillar Inc. is the biggest company in the sector, with estimated 2007 revenue of $44.7 billion. (All figures are in US$ unless otherwise noted.) Japan-based Komatsu Ltd. , with revenue of $9.4 billion for the six months ended Sept. 30, sells much of the same large construction and earth-moving equipment. Money managers prefer Komatsu because it is focused on the booming Asian emerging markets and is a leader in producing energy-efficient machines, while Caterpillar is very exposed to the U.S. housing market weakness.
Moline, Ill.-based farm machinery manufacturer Deere & Co. , with revenue of $24.1 billion in the year ended Oct. 31, is benefiting from the strong demand for better foods in emerging markets as incomes rise, and from the demand for renewable biofuels. Some analysts consider the current stock price too high, but others have rated it a “buy”.
Germany-based truck producer MAN AG, with estimated net sales of 14.8 billion euros ($20.2 billion) in 2007, is a truck, bus and diesel engine producer. The company has been the subject of much speculation recently as analysts anticipate a three-way merger of MAN, Sweden-based Scania AB and the truck division of Volkswagen AG. Both Burbeck and Patricia Fee, money manager at I.G. International Management Ltd. in Dublin, say MAN’s stock price remains attractive.
Here’s a look at the companies in more detail:
> Caterpillar Inc. A report from the New York office of UBS Securities LLC rates the company “neutral,” with a 12-month price target of $70 a share, which is less than the $77 a share at which the shares were trading on the New York Stock Exchange on Dec. 10.
The UBS report warns: “Investors could start to discount a down-turn over the next 12 months, which could exert more pressure on the stock.” The report notes that when the previous economic cycle was approaching a downturn in 1996-98, Caterpillar traded at an average 40% discount to the market.
A report from New York-based Argus Research Co. also has rated the stock a “hold”: “Although we still like the Cater-pillar story, based on the company’s exposure to the fast-growing nonresidential construction and infrastructure markets, we remain concerned with its continuing price pressures.”
A report from New York-based J.P. Morgan Securities Inc. is also wary of Caterpillar. The report says the firm is concerned about declining demand in Caterpillar’s key North American end markets for machinery and trucks.
But, Fee says, investors should keep Caterpillar on their radar screens. The company has put in a new manufacturing production system that could produce significant efficiencies. If that’s the case, the stock price could rise despite the weak U.S. housing market. Fee notes that Caterpillar sells almost 50% of its products outside of the U.S. and also sells machinery to the hot mining sector.
Besides earth-moving, construction and materials-handling machinery and equipment, the company makes diesel engines and provides various financial products and services.
Net income was $2.6 billion in the nine months ended Sept. 30, 2007, down from $2.7 billion in the same period a year prior. Nine-month revenue was $32.8 billion, up from $30.5 billion in 2006. Long-term debt was $17.2 billion as of Sept. 30.
> Deere & Co. A UBS report is “neutral” on Deere, with a 12-month target price of $75.50 a share. An Argus report, however, has a “buy” rating on the stock, with a new target of $90 a share, up from its previous target of $81, as does a J.P. Morgan report, although the latter doesn’t provide a target price. The shares were trading at $89 each on the NYSE on Dec. 10.
@page_break@Fee considers the current price attractive because of the company’s growth momentum. “It’s exposed to the right areas,” she says.
Agricultural equipment is Deere’s main business, accounting for $12.1 billion, or half of the $24.1 billion in total revenue in the fiscal year ended Oct. 31. But the company also sells commercial, consumer (such as lawn care), construction and forestry equipment as well as providing financial services. Fee notes that the construction equipment Deere sells is small to mid-sized and is, therefore, less affected by the weakness in the U.S. housing sector.
The Argus report notes that the outlook for agricultural commodity prices remains strong and Deere has built up strong inventories in anticipation of the demand. The report also cites Deere’s increased investments in Brazil, China and India as another reason for its increased target price.
For its part, the UBS report believes the stock is fairly valued.
Burbeck considers Deere a well-managed company and a good way to play the strong demand for food and agricultural products.
Carlee Price, research analyst at Franklin Resources Inc. in San Mateo, Calif., agrees that management is “really good,” citing a lower and more flexible cost base. But both she and Burbeck would wait for weakness in the stock price to buy.
Deere’s net income was $1.8 billion in fiscal 2007, vs $1.7 billion the previous year, on revenue of $24.1 billion, up from $22.1 billion in fiscal 2006. Long-term debt was $11.8 billion as of Oct. 31.
> Komatsu Ltd. A UBS report has rated Komatsu a “buy,” targeting a 12-month price of ¥4,600 a share, or about 22 times 2007 earnings. That’s a premium over the average price/earnings ratio of 17 for machinery stocks and is justified by the company’s “high-growth potential.” The widely held shares were trading at ¥3,200 ($29) on the Tokyo Stock Exchange on Dec. 10.
J.P. Morgan also likes the company; the share price target in a recent report is ¥4,400. But it mentions a number of risks, including a rise in the value of the yen, shipping delays due to difficulties booking space on cargo ships, slowing emerging-markets growth with resulting delays in infrastructure construction, and a more severe slump in North America than expected.
Burbeck likes the company as well. “Like other Japanese companies,” he says, “it copied the U.S. business model but made it better.”
Dan Rea, one of the managers of AGF Aggressive Global Stock Fund at Chicago-based Driehaus Capital Management LLC, is also enthusiastic. Komatsu has taken a leading role in making fuel-efficient equipment, he says, and gets most of its revenue from booming emerging markets.
Net income was ¥103.8 billion ($902.6 million) in the six months ended Sept. 30, up from ¥67.2 billion a year earlier. Net sales were ¥1.1 trillion ($9.4 billion) vs ¥888.5 billion. Long-term liabilities were ¥269.7 billion as of Sept. 30.
> Man AG. J.P. Morgan and UBS reports agree with Burbeck and Fee about the attractiveness of this stock. Twelve-month price targets range between 146 euros and 140 euros. The shares, of which Volkswagen AG owns 22%, were trading at 106 euros on the European Xetra Stock Exchange in early December.
The UBS report calls MAN “one of the most attractively valued industrial stocks” in its coverage with its P/E ratio of 8.4 times 2008 earnings. That’s a 21% discount to Scania and in line with Volvo’s valuation. The report notes that the 140 euro price target includes “a probability-weighted premium for synergies coming from a potential deal with Scania.”
A J.P. Morgan report calls MAN one of its top picks in the sector. It describes the company as underleveraged and is assuming a one-billion euro share buyback in 2008.
Volkswagen’s 22% stake in MAN is obviously an important factor in the potential merger of MAN, Scania and Volkswagen’s truck di-vision. However, as Fee points out, this is not the only cross-ownership: all three companies own portions of each other.
MAN sells mostly in Europe, where new regulatory and environmental standards have spurred significant replacement demand. The U.S. went through a similar replacement cycle in the past few years.
The company also sells its pro-ducts in eastern Europe, where, Burbeck says, local players are “nowhere near meeting modern standards” and, thus, are not competitive. Both the UBS report and Fee note the increased production coming from a new plant in Poland.
Net income for MAN was 885 million euros in the nine months ended Sept. 30, way up from 669 million a year earlier. Revenue was also up substantially, to 10.3 billion euros from 9.2 billion. Net debt was 493 million euros as of Sept. 30. IE
Global machinery sector offers interesting plays
The complexity of the sector, which is affected by various cycles, means you have to look at each company individually
- By: Catherine Harris
- January 4, 2008 October 31, 2019
- 10:01