Valuation of the heavy equipment industry

Corporate Growth Report Weekly, Dec 2, 1996

The Capital Goods industry has three sub industries: electrical equipment, heavy equipment and machinery manufacturers. The three capital goods market segments have similar valuations even though their end products are different

The capital goods industry is much more cyclical than the U.S. economy. In economic downturns business tends to delay capital good expenditures. When the economy picks up capital good orders usually come in at a rate that is faster than the general growth rate of the economy. The valuation of companies in this industry depend on what part of the capital goods cycle the company is in when the study is being made.

Another factor effecting the valuation of heavy equipment and capital goods companies is interest cost The current rate of interest is favorable for this group. Also, long term interest rates are relativly low which makes it easier for corporations and farmers to finance heavy equipment expenditures.

Companies, in the heavy equipment industry, that obtain a significant amount of their sales in foreign markets usually have a higher growth rate and therefore a higher valuation. The reason is, there is a worldwide built up demand for infrastructure improvements. Therefore companies doing business in the international market have a good source for long term profits.

Companies focusing on Asia and the Southern Pacific Rim have been showing good growth in revenues and the projection for this area looks good for the rest of the decade. In time Eastern Europe and the former Soviet Republics will be a good source of revenue because their infrastructure needs are so great. However customer financing is often difficult for these countries.

Corporations and governments, at all levels, have been making substantial investments in waste management and pollution control facilities do in part to the passage of the Clean Air Act of 1990. Projects in those areas have been very favorable to the heavy equipment industry

Unlike most previous business cycles, companies in the capital goods industry are now in better shape. They have made their organizations lean and debt levels are fairly modest Therefore their breakeven point is lower than comparable periods in the past In fact, most companies in the capital goods and heavy equipment industries state that their pricing is improving.

History is a good place to look to understand how pricing effects the profits and valuations of companies in this industry. At present the local and international markets are in relativly good shape and heavy equipment pricing remains stable. However, in a down turn price stability in this industry tends to fall apart more quickly than in other industries.