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China's surprising resilience powers construction machinery makers

Public infrastructure projects buoy XCMG, Caterpillar and Komatsu

Renewed Chinese infrastructure investment is fueling construction equipment demand. (Photo by Akira Kodaka)

BEIJING/TOKYO -- Growing demand for construction equipment in China is pushing up the earnings of domestic and overseas suppliers alike.

Local governments have been boosting infrastructure investment since last autumn -- a trend clearly reflected in fresh statistics announced on Tuesday. Market watchers predict demand will continue to grow gradually over the next year or two.

"We have learned from our setbacks," Wang Min, chairman of Xuzhou Construction Machinery Group (XCMG), told the Nikkei Asian Review recently in Beijing. Overall sales in China's construction machinery industry are likely to grow by more than 40% this year, thanks to "improved quality and efficiency," he said.

Wang Min, chairman of Xuzhou Construction Machinery Group, is upbeat on the demand outlook. (Photo by Takashi Kawakami)

In the January-September period of this year, XCMG Construction Machinery, the group's Shenzhen-listed unit, saw sales jump 78% on the year to 21.5 billion yuan ($3.23 billion) and net profit soar 370% to 700 million yuan. Earnings at XCMG Construction Machinery and its rivals were sluggish through last year, but they have recovered in dramatic fashion in 2017.

For the first nine months, sales at Sany Heavy Industry and Zoomlion Heavy Industry Science & Technology jumped 70% and 30% on the year, respectively. Both saw their net profits increase as well.

The big thaw

For a few years, through 2016, Chinese construction equipment demand stagnated due to the slowing economy and shrinking infrastructure spending by local governments. But since last autumn, infrastructure investment has surged again in the form of public-private partnerships -- in which governments draw on private funds and expertise to construct public facilities.

Despite data pointing to a mild economic slowdown, infrastructure investment from January to October shot up 19.6% on the year, according to statistics bureau figures revealed on Tuesday. Not only Chinese equipment suppliers, but also foreign players have been reaping the benefits.

U.S. company Caterpillar, the global industry leader, saw its construction machinery sales jump 37% on the year in the July-September quarter, to $4.85 billion. By region, Asia-Pacific sales across all product categories jumped 37% to $4.89 billion.

"Asia-Pacific saw the second-highest increase in dollar sales, primarily due to higher end-user demand for construction equipment," said Bradley Halverson, Caterpillar's chief financial officer and group president said in a conference call on Oct. 24. "About half of the increase was in China."

Looking ahead, Caterpillar remains bullish on the country. "China continues to be a bright spot and a surprise to the upside," Halverson said. "Our current estimate for 2017 is for the 10-ton-and-above excavator industry in China to more than double versus last year, which would result in sales that are higher than our estimate of normal replacement demand for the region."

Jim Umpleby, Caterpillar's CEO, also expressed confidence in Chinese demand. "We continue to see strength in China construction," he said.

Japanese suppliers are in on the action, too. Komatsu announced that its net profit for the year ending in March is projected to rise by 40%, to 159 billion yen ($1.39 billion), based on U.S. accounting standards. The improvement is being chalked up to higher sales in China and other emerging countries.

Komatsu had initially projected a 19% decline to 92 billion yen.

Komatsu Executive Vice President Mikio Fujitsuka on Oct. 27 told reporters that construction machinery sales will mark year-on-year increases in all regions for the current fiscal year. The company raised its full-year sales forecast for the construction, mining and utility equipment division by 169 billion yen from its initial projection -- to a 15% increase to 1.81 trillion yen. China and Southeast Asian countries, positioned as "strategic markets," are providing the momentum.

The question is whether the demand recovery will continue in China and other emerging markets. As of the end of September, Komatsu's balance of inventory assets had increased by about 178.6 billion yen from the end of March. Fujitsuka explained that the company built up extra inventories in view of the order situation in the second half and beyond, indicating that the recovery should go on for some time.

Market watchers are beginning to look at the outlook for next fiscal year, through March 2019. Shinji Kuroda, an analyst at Credit Suisse, said Komatsu has entered a phase of sustained earnings growth thanks to a prolonged recovery of mining machinery demand.

Komatsu's stock price reached 3,945 yen on Nov. 9, not far off the record of 4,090 yen posted in October 2007. The price has risen nearly 50% since the beginning of the year, significantly outperforming the Nikkei Stock Average's 20% increase over the same time frame.

Hitachi Construction Machinery, Japan's second-largest construction equipment maker behind Komatsu, is on a roll as well. It announced on Oct. 25 that its net profit for the current fiscal year is expected to jump 270%, to 30 billion yen, beating the initial projection of a 120% increase to 18 billion yen.

Hitachi Construction credits demand in China along with Indonesia, where mine development is picking up.

One potential concern is that Chinese infrastructure investment could slow now that the Communist Party's twice-a-decade national congress is over. The thinking is that investment tends to swell ahead of the event, to give the economy a boost. This worry is fading, however: Hitachi Construction Vice President Tetsuo Katsurayama said it is not an issue.

XCMG's Wang foresees more modest growth ahead -- about 10% in 2018 and 2019. Replacement demand for larger, more efficient, energy-saving machinery is expected, as the Chinese government tackles severe pollution.

Belt and Road caveats

Over the longer term, China's Belt and Road Initiative -- aimed at building a "new Silk Road" economic zone stretching to Europe by way of land and sea -- is also expected to support machinery demand.

Beijing intends to create a "pro-China" economic zone by building infrastructure, such as roads and ports, in about 70 countries. The government intends to fuel investment with its Silk Road Fund, launched in 2014, and the Asian Infrastructure Investment Bank.

Still, there are some question marks. Many of the Belt and Road countries are in earlier stages of development, and private companies are cautious about investing in potentially low-profit, high-risk projects. Some experts say quite a few investments made by state-run companies are unprofitable.

Wang acknowledged that some of the countries have financial difficulties, unstable politics and restrictions on foreign investment. But he stressed that machinery demand will grow -- albeit only steadily.

Nikkei Asian Review Business News and Market Editor Kenji Kawase contributed to this story.

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