These Machinery Companies Are Still Standing Strong

Includes: CAT, JOY, TEX
by: Fusion Research

Global demand for the machinery industry is facing problems on account of weaker demand from the mining industry worldwide, which is expected to normalize in the coming two years. Machinery companies are adopting various strategies to reduce the effect of this slowdown. In this article, we have included three companies from the machinery industry that are resizing their business and adopting cost restructuring measures to be in line with the global requirements. Let's see what growth opportunities are present in these companies over the coming two years.

Re-sizing the business for lower future outlook

Terex's (TEX) material handling and port solution segment revenue was down by 16% year over year in the second quarter of 2013. Out of anticipation of lower future demand, the company is resizing its business and adopting a strategy of cost restructuring. In the second quarter of 2013, it incurred $47 million for restructuring its cost and closed its production site in Spain, which was underperforming. This will help the company to save approximately $50 million annually.

We believe this savings will have a significant impact on the company's earnings. Terex has an outstanding share of approximately 111 million, and with $50 million annually, it will impact the EPS by $0.45 annually, assuming the outstanding shares remain constant.

On the other hand, in this slowdown, mining companies are using existing equipment rather than purchasing new machinery. This scenario is driving demand in the company's Aerial works platform segment, or AWP, in which Terex rents equipment to mining companies. This was evident in the first half of 2013, where its backlog grew 38% year over year to $497.3 million. This segment will offset the overall low earnings of the company in this weak environment.

With the rental market, its earnings are expected to grow 9.05% this year, and with the gradual recovery, it is anticipated to upsurge to 47.33% in 2014. Earnings growth will impact the forward P/E, which is estimated to decline from 14.50 this year to 9.86 in 2014. We believe with the soft demand for mining, its renting business will offset the current decline in earnings. Over the coming years, this stock has high growth earning potential, which makes it a good option to invest.

Reducing expenses on weak demand

In the second-quarter earnings report the Corporate Controller of Caterpillar (CAT) Michael DeWalt said:

Given the substantial decline in sales in 2013, the uncertainty around when cyclical recovery will resume, we've taken substantial action to adjust our production levels and to reduce cost. We expect to take further action in the second half of the year. Now our intention is to reduce costs and drive operational improvement and do it in a way that doesn't significant reduce our ability to ramp up when production improves.

In the second quarter, Caterpillar's profits declined 43% year over year on account of weak demand for mining equipment worldwide. To bring the production in line with the demand, the company is aggressively laying off workers globally. At the end of second quarter of 2013, total number of employees was reduced by 10,000 year over year. In the third quarter, it has plans to lay off an additional 700 workers globally. Though the company's revenue will be under pressure this year due to weak demand, this strategy will help it reduce the impact of economic downturn.

Growth from mining equipment is largely dependent on demand for iron ore, copper, and energy sources like coal. With the gradual increase in economic activities, the demand of these products is expected to substantially increase in the years to come, as cited in Michael DeWalt's statement. This will drive the company's growth in the long run. Its 12-month expected PEG ratio is 1.45, with a five-year PEG ratio of 1.21. This decline indicates high growth potential in the future, as compared to the current scenario.

We are bullish on CAT. Please read: Does This Caterpillar Have 9 Lives To Survive The Industry Downturn?

Ahead of its cost-saving plan

Joy Global (JOY) is ahead of its cost restructuring plan, which was divided into three phases. The first phase of the plan started in the second half of 2012 and is expected to save $47 million of cost this year, more than the $40 million announced previously. Phase two and three started this year; the company will be reducing production outsourcing and headcounts. Savings from these two phases will be realized in 2014 with a total amount of $75 million, impacting the company's EPS favorably.

In 2013, Joy Global will save $47 million, and with total outstanding shares of 106.46 million, it will impact the EPS by $0.44 this year. With the assumption of total outstanding shares to remain constant, saving $75 million in 2014 will have an EPS impact of $0.70 in 2014.

On the other hand, the price of natural gas is increasing, leading toward the higher demand of its substitute coal for an energy source. According to the World Steel Association, global demand for thermal coal is expected to rise by 3% in 2013 and 2014. Two-thirds of Joy Global's machinery is used in coal mining. We believe that this will have a positive impact on the earnings of the company, as the machinery for coal mining will witness an upsurge. In the current scenario of weak demand of overall minerals, the company will witness earnings pressures, but its PEG ratio of 0.62 depicts an undervalued stock.

Bottom Line

Currently, all the above companies are facing challenges because of the economic downturn. It is interesting to analyze which stock is currently generating returns if we compare it with the industry average P/E.





Joy Global





The industry P/E is 15.10 and all above companies have a lower P/E than the industry. This depicts that all the above companies have high future earning potential.

Considering the long-term fundamentals, and the future strategies we recommend a buy on all thee stocks.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Fusion Research is a team of equity analysts. This article was written by Satya Prakash, one of our research analysts. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.