Worried About Caterpillar? Get a Komatsu Reality Check

(Bloomberg) -- If Caterpillar Inc. seemed to cast a pall on the economy's future health, investors shouldn't be despondent.

The bellwether equipment maker struck hitherto euphoric – and currently sensitive -- investors over the head on a Tuesday earnings call, saying first-quarter earnings “will be the high-water mark for the year.” Signs of optimism elsewhere were ignored, and rising Treasury yields aggravated concern that a lot more than Caterpillar's profits had peaked. The stock sell-off spread to Japan, with competitor Komatsu Ltd. dropping as much as 4.5 percent Wednesday.

Calling a top in the first quarter is unusual for the world's largest maker of machinery, and reflected management's expectation that costs could increase significantly the rest of the year, especially for steel. Caterpillar's problems may be more specific to the company than investors reckoned, however: research and development and other spending was slow in the first period, so it will be relatively higher the rest of the year. 

The macro gloom may be overdone, too. Caterpillar's results showed rising demand for equipment, and higher prices. Those factors should underpin Komatsu, the No. 2 construction-machinery maker, which reports results Thursday. 

The Japanese company's 2016 purchase of Joy Global Inc. for $2.9 billion, at a low point in the resources cycle, now looks like a well-timed bet. The U.S. mining-equipment specialist helped Komatsu diversify just as extractive industries started taking advantage of recovering commodities. That in turn boosted equipment sales.

Mining accounts for about 20 percent of Caterpillar's revenue. Based on the U.S. company's results for that segment, where sales rose 32 percent, Joy Global should have a similar effect on Komatsu.

Caterpillar's conservatism is well-known, too. So while raw materials account for 70 to 80 percent of the cost of goods for construction-equipment makers, the companies benefit from replacement demand for machinery: About 40 percent of Cat's revenue is from construction, where it's forecasting strong growth – another tailwind for Komatsu.

Then there's China, a growing source of revenue for the U.S. and Japanese companies. Caterpillar predicted a possible 30 percent increase in Chinese demand for excavators; just three months ago, its forecast was for 8 percent growth. Asia Pacific sales, mainly in China, increased more than 40 percent, outpacing those in the U.S., its largest market.

Komatsu's excavator sales in China, likewise, rose almost 45 percent in March. There's the risk, certainly, that activity will slow – average hours of use per unit dipped in March. And heightened competition could squeeze the company's market share.

Overall, though, its business in China is growing fast, and utilization rates remain historically high. Excavator sales reached a seven-year peak in March. Stricter environmental-protection regulations at construction and mining sites have lifted demand for higher-end machinery, giving the likes of Komatsu a further leg up.

Investors should seek a second opinion on the health of the world economy. From Japan.

To contact the author of this story: Anjani Trivedi in Hong Kong at atrivedi39@bloomberg.net.

To contact the editor responsible for this story: Paul Sillitoe at psillitoe@bloomberg.net.

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