Komatsu’s Third-Quarter Fiscal 2021 on Track To Meet Full-Year Guidance; Gradual Recovery Intact

Equity Analyst

Ken Foong

Associate Equity Analyst

Pujance Chan

Komatsu is the second-largest construction equipment manufacturer in the world by revenue. Its core construction, mining, and utility equipment business contributes around 90% of revenue. The remainder comes from its retail finance business and industrial machinery and others, which includes metal forging, stamping presses, machine tools, and defense-related equipment. The Americas and Asia are the main markets for Komatsu, accounting for more than 80% of revenue, followed by Europe and the Commonwealth of Independent States. 

Komatsu’s superior product quality and brand name have helped to solidify its leading position in the global construction machinery space, with Interbrand ranking it in the top 20 of Japan’s Best Global Brands for the past 10 years. Komatsu’s focus on providing machinery with low total cost of ownership helps it to appeal to customers as the total cost of ownership includes not only the purchase costs but also all future costs comprising labor costs, maintenance and repair costs, spare parts, interest rates, insurance, depreciation, taxes, fuel consumption, and others. It constantly works together with its customers to provide suggestions and solutions to run its machinery in an efficient manner.

Komatsu has been actively investing in research and development, focusing on artificial intelligence technology and Internet of things. Its notable technological innovations include the first hybrid hydraulic excavator, well-known GPS monitoring system Komtrax, and the first commercialization of an autonomous haulage system for mining. We believe that leveraging advancements in technology helps to drive growth for the company and improve the competitiveness of its products. In addition, Komatsu is continuously improving its aftermarket services through its extensive distributor and service network as well as providing retail finance services to its customers. We give Komatsu a narrow moat rating and expect it to generate an average return on invested capital of 11.3% over the next five years.

Business Strategy & Outlook

We believe Komatsu has a narrow moat derived from its intangible assets, which stem from superior product quality, consistent research and development spending, a strong dealer and service network, and captive finance capability. Considering the life cycle of around 10 years for most construction and mining machinery, good product quality limits the failure rate and enables easy operations. Continuous investment in research and development ensures the competitiveness of its machinery as advancements in technology can improve efficiency of the machinery. Convenient access to a strong and extensive dealer network and the ability to provide competitive financing services also help to lighten customers’ financial burden and improve the user experience. Over the past 10 years, Komatsu achieved an average 14.3% return on invested capital, which is above our estimated weighted average cost of capital of 7.5%. We expect the company to generate an average ROIC of 11.3% over the next five years.We think Komatsu’s construction, mining, and utility equipment business, which accounts for around 90% of its revenue and operating income, possesses a moat. Komatsu’s superior product quality and brand name have helped to solidify its leading position in the construction machinery space globally with more than 10% market share, and the firm has been ranked as the second-largest construction equipment manufacturer in the world for the past 10 years in a row, according to Yellow Table, which compiles data on the top 50 construction equipment companies globally. Interbrand also ranked Komatsu as one of Japan’s top 20 Best Global Brands for the past 10 years and valued the brand at USD 1.55 billion in 2018. Komatsu’s focus on providing machinery with low total cost of ownership helps it to appeal to customers as the total cost of ownership includes not only the purchase costs but also all future costs comprising labor costs, maintenance and repair costs, spare parts, interest rates, insurance, depreciation, taxes, fuel consumption, and others. Komatsu works together with its customers to determine the best machinery that will suit its customers’ needs after considering the total cost of ownership. It also gives its customers suggestions and solutions on the best way to operate the machinery efficiently. As a result, Komatsu was named as one of the Lowest Cost of Ownership Award 2018 winners by EquipmentWatch along with Caterpillar and Deere, based on its calculations on the five-year total cost of ownership of different models across the different heavy construction equipment types. All of these could be done because Komatsu continues to innovate and improve on its machinery by focusing on research and development, incorporating Internet of things and artificial intelligence technology into its machinery along with the advancement of technology, and providing financing to its customers. Among its notable technological innovations includes the first hybrid hydraulic excavator, well-known GPS monitoring system Komtrax, and the first commercialization of an autonomous haulage system for mining. Komatsu has been actively expanding its dealership and service centers network globally and sells most of its construction machinery through its dealers while most of its mining machinery is sold through its own subsidiaries. An extensive dealership and service network has helped to strengthen Komatsu’s brand loyalty. Komatsu has around 18 dealers with around 290 branches in charge of its sales in Japan based on our estimation. Although it does not disclose the total number of distribution branches it has, we believe that the coverage of its distribution network worldwide is quite significant. Based on our estimation, it has around 245 dealers in more than 138 countries outside Japan. For its main markets outside Japan, Komatsu has around 30 dealers in the U.S., around 40 dealers in Europe, and around 30 dealers in China. In Indonesia, Komatsu’s products are being sold by its sole distributor United Tractors, which is also the largest distributor of heavy equipment in Indonesia. These dealers are supported by Komatsu through the provision of technical support and training and can also leverage its advertising, retail financing, and insurance services. This has resulted in a good long-term relationship between Komatsu and its dealers. Given the large market share for its main product categories and the high quality of its products, dealer loyalty is high in many regions. To reduce the financial burden of its distributors and better understand the trend in market demand for its machinery so that Komatsu can adapt to changes in a more timely manner, it launched a “zero inventory campaign,” which is ongoing. Through this campaign, its distributors will not need to keep a lot of inventory and will only need to place orders once they receive it from customers. This will result in customers’ orders being reflected immediately on Komatsu’s order book. Komatsu could then have a better gauge of the real demand for its machinery and adjust its production and sales accordingly. We believe this strategy has strengthened Komatsu’s partnership with its distributors and helped Komatsu to better control its production. Komatsu offers attractive financing services, with down payments as low as zero to 20%, which can alleviate customers’ financial burdens and help smooth the impact of the credit cycle and industry downturns. When credit standards become tougher in a tightening cycle, financing services can make a difference for manufacturers to lock in those customers. The customer usage rate for Komatsu’s financing services is high in its key region, the U.S., at 70%-80%. The default rate has been low, and we believe its high resale value, ample secondary market, and extensive dealer network can make it effective for Komatsu to collect the machinery and recover most of the losses even if a default occurs.We do not think that Komatsu’s other businesses, industrial machinery and others, possess any moat, considering their relatively small scale and lower profitability. Management remains focused on improving and expanding its core business, which we believe will continue to support our narrow economic moat rating.

Narrow

Economic Moat

Komatsu Ltd

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Komatsu Ltd. engages in the manufacture and sale of construction and mining equipment, utility devices, forest and industrial machineries. It operates through the following business segments: Construction Machinery and Vehicles, Retail Finance, Industrial Machinery, and Others. The Construction Machinery and Vehicle segment covers machineries for mining, loading, transportation, underground construction, and recycling. It also includes leveling roadbed for machinery, industrial vehicle, engine, other machineries and equipment, casting and logistics. The Retail Finance segment offers sales financing related to construction and mining machineries. The Industrial Machinery and Others segment covers forming and sheet metal machinery, machine tools, defense related, temperature controlled equipment, prefabricated house for business, and semiconductor exposure equipment for excimer laser. The company was founded by Meitaro Takeuchi on March 13, 1921 and is headquartered in Tokyo, Japan.

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