Komatsu Stock: Beneficiary of Multiple Inflation Trends (OTCMKTS: KMTUF)

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Summary

For 2 years, inflation has been a key theme in my investment strategy. Looking ahead, Komatsu (OTCPK:KMTUY) (OTCPK:KMTUF) is one of my favorite picks for the beneficiaries of inflation for multiple reasons.

  1. Komatsu benefits directly from the inflationary effects of rising raw material prices and rising labor costs.
  2. Komatsu’s low valuation and inclusion in the Japanese stock market provide a defense against hawkish US monetary policy in response to inflation.
  3. Divergent responses to rising inflation by Japanese and global central banks could weaken the yen, providing additional tailwind to Komatsu by increasing its appeal to overseas customers.

I present this thesis in more detail below.

Introduction

Komatsu is a Japanese heavy industrial equipment company with a market capitalization of $22 billion, with significant exposure to the global construction and mining industry. In fiscal 2020, 90% of Komatsu’s sales were made in the construction, mining and utility equipment industry. Summary tables of Komatsu’s corporate profile presentation, including more detailed figures and geographic distribution of exposure, are shown below.

Komatsu Product Summary

Komatsu

Komatsu Product Summary

Komatsu

Komatsu Company Profile Presentation Financial and Revenue Highlights

Rising metal prices will increase demand for mining equipment

Over the past year, metal prices have increased significantly. Rising commodity prices are characteristic of an inflationary environment. In this particular situation, the metals are poised for a sustained price rise due to underinvestment in mining capacity. This has many analysts calling for the start of a new metals and mining supercycle. Metal prices have already started to rise. The Invesco DB Base Metals (DBB) ETF has risen 33.7% over the past year. This has led to an increase in capital flows into the mining industry with the SPDR S&P Metals and Mining ETF (XME) up 60% in the past year. Price trends for both are shown in the figure below, with significant price action beginning around January 2022 with further acceleration in February/March following Russia’s invasion of Ukraine.

Chart
Data by YCharts

Rising labor costs will increase demand for self-contained equipment

The pandemic-era fiscal stimulus has created a very tight labor market coupled with record highs in recent history for labor measures such as total private job openings and total non-farm quits. Consequently, labor costs begin to rise at high rates: the average hourly wage of all employees, total private sector increases at a rate of more than 5% per year. Since labor is a key input into most goods and services, it is an important driver of headline inflation.

Plot of Labor Market Measures

Fred

Komatsu is well known for its autonomous mining equipment. Komatsu says automation can drive savings of up to 15%, increased production while promoting zero damage, consistent operation, optimized dispatch and real-time decision making. The technology is quite impressive; interested readers can view videos of Komatsu autonomous equipment on YouTube. This technology has earned Komatsu a 4.3% weighting in Cathie Wood’s ETF ARK Automation (ARKQ).

Global government investment in clean energy and resource independence will increase demand

A confluence of macroeconomic conditions has set the stage for sustained global investment in natural resources. First, near-zero interest rates and the exhaustion of quantitative easing capacity in developed economies will require fiscal stimulus to manage economic downturns in the future. Investments in green energy are a natural target for fiscal stimulus, which will eventually increase demand for materials such as copper to support green energy infrastructure. Bridgewater Associates has written extensively about the likelihood of a green energy fiscal stimulus. Secondly, this is amplified by the geopolitical tensions which multiply the calls for the energy independence of the developed countries. Not only will energy independence require investment in green energy infrastructure, but it will likely also come with the desire to develop the capacity to produce the required upstream materials. We see this playing out now in the United States with Biden taking steps to increase strategic mineral supplies. The global energy transition and de-globalization trends are two key drivers of future inflation.

A low valuation offers protection against rising interest rates

One consequence of rising inflation is the need for global central banks to respond by withdrawing liquidity. This objective will be achieved by raising interest rates, both in the short term through interest rate policy and in the long term through quantitative tightening. The result of this tightening is that the risk-free rate will increase. For example, the 10-year US Treasury rate is currently around 2.7%, up significantly from a low of 0.5% in 2020.

u.s. treasury rate chart

Fred

This rise in interest rates effectively reduced the present value of all financial assets, especially long-duration assets such as high-growth stocks and long-dated bonds. The chart below shows the impact on unprofitable growth stocks represented by the ARK Innovation ETF (ARKK), technology stocks represented by the Invesco QQQ ETF (QQQ) and long-duration Treasuries represented by the iShares 20+ Year Treasury Bond ETF (TLT).

Chart
Data by YCharts

Komatsu in comparison is profitable with a PE 2022 of 11.59 and a PE 2023 of 10.85. On an earnings yield basis, that’s a 9% yield that offers a comfortable spread above rapidly rising Treasury rates.

Profit estimates for Komatsu

Looking for Alpha

Japanese stock market less sensitive to liquidity withdrawal

Finally, Komatsu is a Japanese stock, which gives it additional defensive characteristics against the US Fed’s hawkish policy response to rising inflation. First, the Japanese stock market is generally considered less sensitive to US liquidity than the US stock market. Therefore, it is also to be expected that the Japanese stock market will be less sensitive to the drop in US liquidity. The U.S. stock market, by comparison, has benefited from increased U.S. liquidity partly because U.S. liquidity tends to flow into U.S. markets and partly because the U.S. stock market is more focused on technology stocks from long-term whose valuations benefit from low interest rates.

In addition, rising US interest rates should also strengthen the US dollar. At the same time, Japanese monetary policy is still relatively accommodative, which has led to a weakening of the yen against the US dollar, which has manifested itself in some recent extreme downward movements in the yen. A weaker yen should be expected to increase foreign demand for Komatsu products, which will become cheaper relative to foreign competitors. This could provide additional tailwind to Komatsu resulting from US and European central bank responses to rising inflation.

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