Joy Global recently reported a solid quarter and it appears the mining equipment market at least found a bottom and may have turned the corner at Joy.
The soft global economy and mining capes spend has weighed on the stock for the past few years. Since the start of 2013, Joy’s stock is down 30% while the S&P is up 38%. It has underperformed the market, not because it is a bad company, but because demand dropped significantly in its end market.
The stock traded as high as $100 as recently as 2011. Even a moderate turn around in demand could drive the stocks significantly higher. For the value investor, Joy Global might represent an opportunity in a market where value is increasingly tough to find.
Joy Global is a Wisconsin based manufacturer of mining equipment for both surface and underground mines. Coal mines are its largest end market typically accounting for 70%+ of annual sales. It does have a significant aftermarket business that is more stable than the OEM portion. Aftermarket sales average around 60% of sales. OEM sales fluctuate along with the capex cycle at mines.
It is generally one of two or at most three competitors in the products in manufacturers. As a result, margins are high. Bucycus was its largest competitor, but is no longer independent as it was acquired by Caterpillar. Its shovels, shearers, and service levels are considered the best in the industry.
Chinese competitors have emerged and sell equipment at greatly discounted prices. The Chinese competitors are not having significant success outside of China, but could emerge as a competitor in some geographies like India, Indonesia, and Russia. Joy Global is not in the truck business, probably the most volatile part of the market.
Joy Global’s customers are the large global miners, mainly Vale (NYSE: VALE), Rio Tinto (NYSE: RTP), and BHP Billiton (NYSE: BHP). In addition, it sells to other miners in China and the rest of the world. The U.S. underground coal market historically is important to Joy Global but the increase in natural gas production and consumption for power has hurt that part of the business. The domestic coal portion will struggle to ever reach the peak levels it hit in the past decade.
Currently over 30% of U.S. met coal supply has production costs higher than the current price. This dynamic is not likely to shift unless there is a substantial increase in U.S. steel production.
Order Activity Drives the Stock
Movements in the stock are most closely correlated with bookings which swing with capex at the miners.
Mining companies like BHP invest when prices of commodities are strong and the outlook is for continued growth in demand. Bookings started to decline in 2012 and took an even larger hit in 2013. This led to the selloff in the stock. However, management forecasted in the prior chart that 2014 books will come in at least even with 2013. There is likely upside to this forecast since Joy’s management team is typically conservative with guidance.
Improvements in the global economy and increasing demand from the developing world are the primary drivers behind order activity and potentially a rising stock price. While demand related to iron ore will likely be weak, copper, coal, and oil sands projects can lead to growth for Joy.
Copper has the best fundamentals currently according to Joy management. New production has consistently been offset by higher demand, meaning the market stays close to equilibrium.
Internally the company consistently leads the market with its technology. It recently introduced a new hybrid shovel/excavator that has the lowed total cost of ownership in the industry. It also developed a high performance low seam longwall that provides a 40% increase in production of current technologies and a 70% reduction in manpower.
Joy efforts in automation extend into the service side as well. Its machines tell owners they are going to break before they do. This is critical for miners because when the machines go down, production stops and cash flows turn negative. Its life cycle management (LCM) program monitors machines remotely, improves productivity and cuts costs for its customers, and provides increased aftermarket sales.
Its most critical source of demand is the developing world. And while China is cooling off and expects to grow at a slower pace. Over the next five years, developments in India and the non-BRIC markets could reaccelerate sales. The developing markets are still very early in their development and their consumption of power, steel, and raw material significantly lags the developed world. This will change over the coming decades and Joy will benefit through rises in commodity production.
Commodity prices and production will continue to fluctuate but the long-term trend remains one of growth. Joy Global is a high quality company that is a direct play on this dynamic.
The stock trades at 9.3x EV/EBITDA and 16.4x NTM earnings. These are typical mid-cycle valuations for the stock but with earnings closer to trough levels, there is upside to the shares. If earnings return to consistent growth, behind steady emerging market growth, recovery in the global economy, and internal initiates at Joy, the stock has upside. At current levels, the downside risk is minimal baring a collapse in the global economy.
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