China has announced a slew of infrastructure projects worth more than $100 billion over the last week to stem its slowing economic growth.  The projects totaling 21 in all include construction of subway and light rail lines in 23 cities, 13 highway projects spanning 2,000 kilometers, 10 municipal-level projects and three ports and waterway projects. Since April this year, the Chinese government has announced projects relating to airports, energy production, highways, railways and waste-water treatment plants with a total investment exceeding $134 billion. These infrastructure projects augur well for Caterpillar (NYSE:CAT) as they will increase the demand for construction equipment and machinery manufactured by the company. This will have a significant effect on its overall growth as the Chinese market constitutes a significant portion of the company’s top-line growth.
Sales of construction equipment in China were impacted in first half of 2012 due to high interest rates
Caterpillar suffered in the first half of 2012 as sales in its Construction Industries business division declined in China. The efforts by the Chinese government to control inflation, which remained above the government mandated 4% for the most part of 2011 and early 2012, hurt the construction sector of the country by dampening investment. This impacted Caterpillar and other companies such as Komatsu and Sany Heavy that operate in the Chinese construction industry.
Further rate cuts will benefit construction equipment sales
However, the high interest rate regime caused inflation to decline significantly. The Consumer Price Index (CPI) inflation touched a 30-month low of 1.8% in July.  Such low inflation rates provide the Chinese central bank, the People’s Bank of China, more room to lower interest rates and provide further scope for economic growth. At present, the benchmark lending rate stands at 6%, which is still high compared to rates in the U.S. and other developed countries. If interest rates are lowered further, sales of construction equipment and machinery manufactured by Caterpillar will benefit through increased investment in construction activity.
Hence, the Chinese government’s recent announcements on infrastructure projects along with the possibility of further rate cuts bode well for Caterpillar. Over the long term, China’s continued urbanization, investment in infrastructure and increasing demand for energy will continue to add to the company’s top-line growth.
We currently have a stock price estimate of $95 for Caterpillar, approximately 5% above its current market price.Notes:
- Chinese Shares Surge on Hopes Based on Stimulus Plan, September 7 2012, www.nytimes.com [↩]
- China inflation rate dips to a 30-month low in July, August 9, 2012, www.bbc.co.uk [↩]