In a gold rush, mining is for muppets: the real profits are in pickaxes. While the past five years have been pretty tough for companies selling excavation, earth moving and crushing equipment, this week came signs we've reached a turning point. But though "global reflation” might be more than just an investment fad, capital goods company valuations already price in a lot going right.
Volvo AB’s construction equipment orders jumped by a third in the first quarter and Sandvik AB’s mining and rock-technology unit achieved a similar gain. "These are numbers that we haven't seen seen since the rise of China in the beginning of 2010" Sandvik's CEO Bjorn Rosengren said on an investor call. "We are in a sweet spot when it comes to equipment for the mining industry."
Even long-suffering Caterpillar Inc, the world’s biggest maker of construction and mining equipment, eked out its first quarterly increase in retail machine sales since 2012. Caterpillar says it sees signs of recovery in several of the industries it serves and on Tuesday it raised full year revenue guidance.
It's not just that China has continued to defy predictions of an impending investment slump -- Volvo raised its growth forecast for the construction equipment market there to as much as 30 percent this year, compared to a previous maximum of 15 percent. The recovery appears more broad-based than that. Volvo said there had also been decent growth in Indonesia and India, as well as in Europe, where the construction equipment market expanded 17 percent year on year. Sandvik said North American adjusted mining orders expanded by one quarter .
Still, it’s easier to post strong growth when demand has been in the doldrums. This is what’s happened to Volvo’s construction equipment sales since 2012 (last year these accounted for about 17 percent of the group's total). Caterpillar Inc.’s top line tells a similar story.
After mining capex contracted by about half since 2012, there's clearly some pent-up demand. Barclays expects spending in the industry to climb by almost one-fifth in 2017. That's good news because equipment typically accounts for about a third of mining spend.
But don't get too excited -- this almost certainly isn't the commodities super-cycle 2.0. While miners can’t avoid maintenance spending -- Sandvik's CEO said after five years it often makes sense to replace equipment -- most aren’t considering new greenfield investment. Instead, companies like Anglo American PLC are focused on cutting debt, and boosting free cashflow. That's probably sensible, as iron ore prices have plummeted in recent weeks. That's also a reminder that being exposed to the right commodities matters -- Sandvik said growth had come from gold, silver, zinc and copper.
Fortunately, capital goods companies have used the downturn to restructure and cut costs. That’s reflected in their improved profitability -- Sandvik’s first-quarter operating profit jumped 45 percent year on year.
Yet investors looking to profit from these developments may have left it a little late. Volvo’s shares climbed to a ten-year high on Tuesday. Forward price earnings multiples for European companies with mining and materials divisions, like Atlas Copco AB, Weir Group PLC and Sandvik, are also looking quite rich. It's worth pointing out that one key investment support -- Trump’s $1 trillion infrastructure plan -- remains more a promise than a reality.
While capex appears to be recovering, reflating share prices further from here will require rock solid evidence that higher spending is here to stay.
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