Joy Global Inc. (JOYG)
Robert W. Baird Industrial Conference Call
November 8, 2011 12:50 pm ET
Mike Sutherlin - President & CEO
Rob McCarthy - Robert W. Baird
Rob McCarthy - Robert W. Baird
So I think we are going to get started now. Good morning everybody. I am Rob McCarthy. I lead Baird's research team for machinery and diversified manufacturing stocks. And I am pleased this morning to be welcoming Joy Global back to the Baird Industrial Conference.
Joy Global generates an unusually large share of its revenue and an even larger share of earnings by providing mining companies with the aftermarket replacement parts, consumables, and services needed to achieve lowest cost per ton production and lowest product lifecycle cost.
Joy has also been an active participant in industry consolidation with the important LeTourneau acquisition in June, and the pending $1.4 billion acquisition of IMM, the leading indigenous supplier of underground coal mining machinery in China.
Today, we are joined by President and CEO, Mike Sutherland; Executive Vice President, CFO, and Treasurer, Mike Olsen; and President and Chief Operating Officer of P&H Mining, Randy Baker.
I’ll turn it over to Mike.
Thanks, Rob, for the introduction, and it’s first of all my pleasure to be here at this conference today. I want to have this opportunity to talk you about commodities, about mining, and about Joy Global. And during the presentation, I want to, really want to concentrate three things. I want to talk to you about our outlook for the commodity markets and how that outlook will drive demand for mining equipment. Secondly, I want to talk about how we have performance and programs that will translate that positive outlook into improved performance for our shareholders. And then third, I want to profile some of the strategies that we use in our business that I think is adding value to our top-line and to our bottom line.
Well, before I go further, I just need to caution the audience that the presentation and the comments I make today will contain forward-looking statements, and need to be interpreted accordingly.
I believe that we are still in the very early stages of a long-term multistage growth cycle for commodities. As I look at the markets we serve, they are definitely driven by the demand out of the emerging markets, whether that is population growth in the emerging markets, urbanization, or industrialization. And as a result, our view is that we expect the commodities to remain supply constraint over the long-term.
Despite concerns about macro issues, which are plenty of those out in the marketplace today, we still see very strong fundamentals in the mining industry. We still have customers that are learning mines globally at or very near full capacity. We still have pricing levels for commodities that provide sufficient incentive or continued mining expansion.
In addition to that, we still have, we have customers that are better off today than they were in 2008 it was up in comparisons made for 2008. Customers today have much better balance sheet; they are sitting on very strong cash balances compared to where they were in 2008. To our last customer they will tell you that they regret shutting down projects in 2008, trying to restart them in 2010. It costs them too much time and money and they wish they wouldn’t have had to do that. Today they have enough financial flexibility to have it, as the decision capability of whether to or not to. And I think they will continue to move forward with their projects.
We certainly see our customers have a strong preference to spin their cash on CapEx for organic growth. There is very little M&A activity and there is very little disposition of return cash to shareholders.
As we take a look at the commodity environment, first look at the copper environment. For me, copper is a commodity that has constantly supply constraint. Production from the major copper producers this year is down both year-over-year and sequentially from the second quarter down to the end of third quarter. And those declines are pretty significant. They were down 8% sequentially, 15% year-over year. Those kind of declines are pretty characteristic of the copper markets and they are driven by a couple of things that create supply disruptions, production disruptions. It’s almost unusual for copper producing company to make it’s production forecast. And as a result of constant disruptions, labor disruptions; geology, weather disruptions, and those have become so frequent that they are now predictable.
If you look back over the last five or six years, you see the difference, disruptions have taken about 6% away from production levels in the copper industry in general. To the point that today we can predict those 6% losses.
Secondly, the other head win that they have is constantly declining ore grades. The ore grades have declined by 20% over the last decade, as the better areas of the mines have been mined out and they have now moved into areas of the mine that have lower ore grades. So that ore grade decline challenges our customers to keep production rates up, because they have to move more raw materials to give them a leveled output.
It’s good for mining equipment because the demand is more mining equipment for given level of copper output. So with those conditions prevailing in the copper industry we see pricing levels that continue to stay at 3.50 level or above, we see some resistant points at 3.50. That provides adequate incentive for continued mine expansion.
Our long-term view in copper is that they will be – industry will be challenged to find new sources of copper to keep up with the growing demand that is coming out of the emerging markets and it will take all copper production even the highest marginal cost producers to provide supply that enable to meet their future demand. So we see the copper industry being a broad growth industry among lower cost, as well as higher cost producers.
If we move to the iron ore sector, we see in iron ore industry, an industry that’s driven by the highest marginal cost producer. Today we have almost half of the world steel production capacity is in China. And yet China has very limited reserves for iron ore. And the reserve they have are very low grade and high marginal cost. So in effect China becomes a swinging producer. In iron ore, more recently we have seen a significant drop in spot prices, and there is some concern about what’s that going to do to the industry. But in effect that’s dividing the industry between a high grade lower cost producers and low-grade higher cost producers, and is forcing the high marginal cost producers out of production.
There is still a significant incentive for the high grade lower cost producers, the ones that are producing in Western Australia, South America, and in Africa. They continue to expand their mining operations and we see prior to-date they expand the iron ore production in those three areas by 50% between now and 2015, and those projects continue to move forward.
As we look at the global coal markets, the -- our markets that are driven by the emerging market demand without a doubt. We see net coal shipments in the emerging markets up 32%. We see power generation in those countries that are served by the seaborne markets up 15%. And coal demand is going to continue to be strong with over 200 gigawatts of coal fired power generating capacity under construction and will come online by the end of this year in those three markets. They will drive another 6 to 700 million tons of coal demand in the seaborne markets.
China and India are obviously the primary components of seaborne demand. In China, we see power generating demand is up 8%. We see domestic coal production, excuse me; the power generating capacity is up 12%. The domestic coal production is up about 8%. The gap being filled by seaborne traded coal.
We see in India power generating demand up 8%, coal production is actually down 3%, and even a higher gap is filled by imported coal. At the same time we see Japan bringing on coal fired power plants to offset the loss of nuclear plants, we still have to be upgraded before that can be brought back online. And we see in Germany taking off 8 gigawatts of nuclear capacity to meet some of their critical targets and that will be back fueled by excess available coal fired capacity in that market. So, we see strong seaborne demand out of the international markets and we see that benefitting a number of countries like South Africa, Australia, Indonesia, and also the U.S.
The U.S. has become much more diversified, much more broadly based coal producing market, driven by the growth in exports. Exports of U.S. this year should be around 105 million tons that will put them at the highest levels since 1992. It’s also a high growth coming out of thermal coal exports. Thermal coal exports are running double where they were last year, and that’s feeding into the strong seaborne markets and also taking advantage of the weaker U.S. Dollar. As a result, we plan the U.S. to be a no growth market and it’s actually delivering some upside. We see some projects right now, some new mine expansion projects underway in the U.S. a very few of them driven off the opportunities to increase export volumes.
We also see major coal producers expanding or investing in the expansion of coal load imports in the West Coast, the PRB coal into the seaborne market - specific seaborne markets. So we see a lot of things going on in the U.S. market that will keep that market a growth market, a low growth market but still a growth market in the U.S.
As we take a closer look at China, I look at China and see China to be really a market driven by two main principle factors. One of those is strong commodity demand. They will talk about the strength in thermal coal demand that comes off the growth in power generation. We see that continuing in China as they build out the electricity grid in the western provinces.
We also see hydroelectric power down in China this year because of low water flow. So that’s another 50 million to 60 million tons of coal demand that’s got to come out of the either domestic production out to seaborne markets. And in China we also see, from an equipment standpoint, we see a much higher demand for equipment in the China market as they continue to drive part of consolidation or mechanization of the local domestic mines in China.
The second factor we see going on in China is a cycle of destocking, restocking. And China was definitely in destocking mode in the first half of 2011, reducing pretty significantly their imports of coal during that period, but also reducing their imports of copper. We see them moving starting the May and June of this year we saw they are moving back into a restocking phase and we expect that restocking phase to continue during the second half of 2011.
This commodity outlook around the world translates into strong CapEx for our major customers, strong CapEx for all of our customer across all commodities. We see the major customers giving four or five year forward CapEx of very strong number. So we see them certainly, the longer-term project sequences of projects to meet there expansion and expectations over the next fiver years, and all those numbers were up very significantly from where were we saw them at the start of 2011, as we started this growth phase.
We translate that into prospects for our equipment. We track projects that are moving into the equipment selection phase, and we look very closely at the projects that are in the last 12 months before we make equipment selection. Our view on that is still very strong, we see the pipeline very strong, we see the prospect list at the end of our third quarter went up, despite strong bookings for us. And so that said that we have more projects being added to the pipeline that we took out by booking, and this is a very positive statement on the strength of the pipeline.
As we look today, we expect our customers to continue to drive the projects forward that are deep in the pipeline, with the projects that are 12, 18, maybe even 24 months from the equipment selection phase. We see that continuing to be driven forward.
We also, between the lines read more caution among our customers about adding new projects to the pipeline. At this point, we see a little bit more tendency to let projects slowdown a little bit as they get more clarity on the macro factors. But certainly, the visibility of the project pipeline for the next 12 to 18 months is still remains very strong, and we see our customers getting a little bit more cautious, until I get stronger reach on the macros.
On top of this outlook from the markets we serve and the strong demand that does generate for our business, we still have a business that’s driven around very strong strategies. And we have strategies in our business that are delivering strong incremental values for us. One of those is our operational excellence strategy. It’s doing a lot of things to improve the efficiency of our processes on our factory floors; most importantly it’s reducing our cycle time in our businesses. We see the build time for shovels went down from 15 months to 5 months, much faster cycle time on that, on the shovel build, demonstrating the efficiency we’re getting in our manufacturing processes, but it’s also delivering us realizable capacity within group line.
Same thing with our longwall shearing machines have gone down from eight months to five months. Those kinds of operational excellence programs are allowing our legacy facilities to compete with our latest state of the art facilities that we’re building in China. So, the operational excellence programs continue to deliver value for us in numerous ways.
We also have a very strong strategy around lifecycle management. It’s a core principle in our business and it really translates to the philosophy of our business around strong aftermarket, delivering very high levels of machine reliability. The reliability of the machines are very valuable because we have mission critical machines and reliability translates into downtime or loss production for our customers. That is a basis for customer preference for our equipment and allows us to sell equipment at premium prices and strong margins. So for us we look at the aftermarket as a very offensive part of our business. It drives the strength in our original equipment demand and an installed base drives more aftermarket.
Some investors will look at aftermarket as a defensive strategy. It provides stability of revenue and earnings throughout the cycle and it does do that. But we manage it internally from an offensive standpoint; it drives strong demand for original equipment.
We were also been translating our aftermarkets on transaction-based or program-based trying to move from transaction to transaction to incorporating that into a stronger list of programs. Life Cycle management programs for us will take the form of cost per ton programs and the long-term maintenance and repair programs for equipment. Well we take responsibility to market the equipment, order parts, manage repair, parts replacement, or rebuild cycle. We see significant improvement in the performance of the equipment on those kind of programs and our customers are seeing significant value.
As a result of that, those program based aftermarket numbers are continuing to go up in our business as we buy more of our aftermarket into those programs. For us, that gives us better predictability and also increases the capture rate from the transaction-based aftermarket.
The next level for us at aftermarket is a product we call Smart Services and the core part of that for us is remote condition monitoring, remote diagnostics, and tools that our customers can use remotely at the mind management level and also at machine operator level, to optimize the cutting loading cycle. And those programs have delivered significant value to the customers who have used them. They are seeing the ability to maintain even higher levels of machine reliability for doing meantime between failure analysis, which is improving the predictability of our parts demand, which has improved our parts planning on those programs. And it also feeds back into our engineering organization, to look at ways to upgrade the components to improve the meantime between regarding both in terms of time to failure, but also the variability of the time to failure to improve the predictability.
So those programs that we piloted in South Africa are now moving out into other markets like the United States, moving out into Australia, and we have that market in China as well. The move into those markets has been pulled by the customers much as it’s been pushed by us. I think it demonstrates the strong value that our customers see in these programs.
We also have a strong strategy around the investment in China. We’ve been investing in China since 2003 when we built our first service center in Inner Mongolia, and Baotou, serving the major mining operators that operate in the Inner Mongolia Northern Shaanxi region. But it’s also been building at our manufacturing campus in Tianjin, where we are building our campus that we call a Center of Technical Excellence.
We have got two factories onsite now and as we move production out of legacy markets into the Tianjin campus, we also go through a leading out base. So as those processes get moved over, we are using 15% to 20% lower labor content on the manufacture we are doing in China, than we were in the same processes that were moved out of our legacy facility, so significant improvement in the efficiency of the operations in China. And therefore, they are our lowest cost operations in there global fleet of equipment.
They are the lowest cost because of the improvements we have made in the processes in the high level of machine automation we have in those factories, they are not lowest cost because we are leveraging low cost Chinese labor. We do that to get high levels of scalability and high levels of repeatability of the China manufacturing campus.
We are building the next stage of that is a factory that will be focused on underground equipment, and that will double our capacity in Tianjin, and bring our total capacity in China up to about a million square feet of floor space in China. We think that that is a very strong and competitive program for us. And we think it puts us in the right place and the high growth place of our markets. And we also think that it’s delivering value to us in terms of lower cost and improved operating profitability.
We made acquisitions. As Rob said, we made acquisition of LeTourneau earlier this year. That’s a two-stage acquisition. LeTourneau was available to us on an all or nothing basis. We acquired LeTourneau Technologies and then we looked at the business, we are prepared to do both the mining and the drilling part of that business.
Drilling has always been part of our strategy, but it’s much quicker out on the horizon. We were not comfortable with the green portion so moving that out in the schedule and accelerating the acquisition into the drilling equipment business. We started looking at options and we decided that staying in the drilling equipment business would spread our focus and force us to undercapitalize the investment opportunities we had in mining. So we look for a strategic partner and we move that, the drilling part of the business up and at the end of October we complete that transaction.
And it was good for us, because it allowed us to get back to mining and focused on building out the portfolio of equipment in our mining product base and doing that first, and then we will keep looking at the drilling space as a later part of the strategy but it’s not on a current horizon at this point.
As we look at the loaders, it does a significant advantage for us in providing an additional solutions to the surface loading market for some. Today we address surface loading with a growth chart, related growth chart. The large wheel loaders provide another access to that surface loading market but it also provides an access to mines that are not electrified, which opens up some different market opportunities for us. So it’s a very complimentary product, locations, and service integration in the field will be to run very smoothly. We see that to be a significant contributor to revenue growth and to incremental profitability for the business.
It’s a product that has some very unique advantages. It’s got the two largest model sizes in the industry, so it’s got an uncomparable pay load capacity and it’s also electrified by real drive per unit, so it’s got significant fuel efficiency advantages by regenerating and reusing the energy during digging and lifting cycles. So that’s a product that’s got significant amount of customer interest and we think it’s a right addition to our business. It’s a high quality business. It’s got strong aftermarket and it’s a strong margin business. So we think it’s a quality addition to our business.
The other acquisition we made is, we are in process on is IMM, our International Mining Machinery, is a manufacturer of equipment scheduled for the domestic China market. The market in China that we have been serving with our imported equipment is a large state-owned mines. That market is comprised of got 20 customers. There spend for equipment is about $2 billion a year. The middle tier market is made up of smaller state-owned companies, majority of it is provincially owned mining companies. Now there are a couple of 100 customers and there annual spend for equipment is $6 billion to $8 billion. So significantly larger market and IMM gives us a great entry point. It’s also a business that’s got the quality products we’re looking for the road headers and shearing machines are very similar to the continuous miners and shearing machines we have in our Joy branded business. It’s a base that we can build and leverage just like we have in our Joy business. So we think it’s a great entry point. It’s a leader in its market. It’s got great brand recognition, strong customer base.
We are going to mark on approval. Everything is going on schedule. We are cautiously optimistic. We think we will complete the transaction by the end of the year. We will do the delisting early next year and we will start the integration of IMM of what we think again, high quality business, strong aftermarket, strong margin business that will enhance the earnings accretive from day one.
As I said, our strategies are helping us deliver profitability in our business. In addition to our strategy we have just a relentless focus on incremental profitability in our business and we keep driving that incremental profitability for the target of 45%. We would also include things like operational excellence or improving the velocity of our working capital that all translates into strong cash flows for our business. Where our business despite being capital intensive, has extremely strong cash flows and allows us to accumulate cash to use for acquisitions or provide the flexibility to take advantage of opportunities in the market as we go forward.
We are also a business that’s been considered to be a cyclical. And large capital equipment manufactures are all often characterized that way. But if you look at our performance over 2008, ’09, ’10 period, you will see a dramatically different story. We used our backlogs and our strong aftermarket business to level out our revenues of that ’08, ’09, ’10 period, and we used our focus on incremental profitability, we used our operational excellence, and we used a scenario planning exercise to look at ways to take structural cost out of our business and get prepared for the uncertain market we saw ahead of that time.
All those things translated into true profitability of that same period of time. Through doing that, we position of business by the end of 2010, to be well positioned and take advantage of the return of strong growth we saw in 2011. So I think that the numbers speak for themselves and it shows that we are a much more stable and much more predictable business over the cycle than the stereotype would have us.
So as I want to just sort of conclude and wrap up, I would like to sort of leave you with a couple of comments about our business. We do have a business ahead, industry leading positions both in the products that we sell and in the markets that we serve whether they are commodity markets or geographic markets. We are a business that drives ourselves to be both operationally and financially efficient business and that’s allowed us to deliver a real strong operating profit margins, our incremental profitability is very strong. And it’s also translating down into improved asset velocity, improved return on assets.
So that financial strength is a real aspect to our business. We are also a business that focuses on the long-term as well as the short-term. We make long-term investments in our business to continue to revitalize our business. Those investments are CapEx. They are acquisitions but they are also R&D programs that continue to drive technology improvement and the next level of product in our current markets and open up adjacent markets to us.
The strong balance sheet gives us the flexibility and the opportunity to take advantage of opportunities when they come up. So I think that we are a market that is well positioned to serve the markets ahead. We think those markets will continue to be strong, even if we move into periods of uncertainty, we think we have the business that’s well positioned to take advantage and perform during those periods of uncertainty.
And in short, I think, Joy Global is a great investment opportunity.
So with that, I will conclude my formal remarks and thank you very much for your interest. So maybe open the floor to any questions that come off the floor. Guys you got to help me up because Bob is going to ask me a question if you guys don’t.
Rob McCarthy - Robert W. Baird
Hey Mike. I am sure everybody would be interested to hear your prospective on how CAD’s acquisition of (inaudible) changes the industry dynamics. And as a follow-on to that it would be my observation typically when you put large capital equipment companies together nimble competitors are usually able to take advantage of that on a market share bases. Perhaps you could update us on your ability to use the changing dynamic to your advantage.
Yeah this is a fairly broad question. As we look at the competitive landscape certainly CAD is a large significant competitor with a lot of strength in the marketplace. I do think that the capability of CAD in the mining market is sometime is overstated when they talk about 35,000 dealers around the world. They don’t have 35,000 dealers serving the mines around the world. They have 35,000 dealer serving construction, engines, and a few other things. But you get out to the mining; we could be facility by facility location-by-location very well.
I also think that the direct model is really right for our business and our products that we have in our portfolio. We do a tremendous amount of customization of the equipment. We have an unbelievable of number of people that are constantly in are customers offices and mine sites everyday, working on projects, working on equipment configurations, and options and other design concepts that we can used to match equipments specifically the customers mining operation. That level of customization is highly valued by our customers.
We have projects where we do funding engineering, studies with the customer, we design and build equipment through contract, we commission start-up equipment, and we take Life Cycle management like long-term lifecycle management contracts at the back-end.
I think it demonstrates the value that the customer has in that direct relationship easy access to us whether it’s me or whether it’s Randy for P&H or whether it’s engineering of service people, direct access from the customer to any point the organization where they need to get through to get issues resolved.
So, I like that very much. We are also on our business that our direct model is very focused and very responsible to issues at field level. And I think we can support our equipment with a direct model much better than going with the inter modal. And we've been demonstrated that we have equipment that they invariably have the highest levels of machine reliability, the availability of the fleets and we get that because we have a very focused aftermarket that we control. We also get that because out of our 15,000 people we have 4,000 of those who job is go to mine site everyday to support our equipment running under lifecycle management contracts. They mark our equipment they look at where light, they look at production rates, they order parts, they plan repairs, rebuilds, ware part replacements and all that adds value to our customer. So, I like our model, I think its right for our business and I think it’s the right model for the industry, and our customer certainly have grown up on that model and they are very comfortable with it. I like our chances to be focused and do well, what we are doing well. We are not going to package up equipment. We are not going to package discounts. We are going to continue to focus on incremental value to the customer, and I think we will do very well with that.
Could you comment on what might be a secular -- can you talk about labor dislocations, but I am just worried about from a taxation and from (inaudible) and whether that could be a secular headwinds or whether it can be (inaudible).
The question was about our views on secular trends that could become head headwinds, in our market things like taxation and regulation. Certainly, well the reasons we see the US to be a low-growth market thermal coal is around regulations, and we just don’t see new coal-fired plants being built in the US. We see a strong base from existing plants that are operating here, base level plants, and we see growth out of the export markets but not out of thermal demand in US. As we move around the world, there is increasing trend for taxation in different forms and fashions. Countries look at declining markets as opportunities to improve governmental revenue.
Its not uncharacteristic of what we have already seen in oil and gas industry, in most cases the oil and gas industry has same kind of taxes, and higher tax ratio were seen in the mining industry. So from that standpoint, mining is catching up to what we see in the oil and gas industry but I use Australia, for an example. Australia has got grade reserves there are high quality reserves; they will be competitive even with the currently proposed tax rates. They many not be as high as our customers would like. They may push prices up in the market and require higher incremental prices to continue mine expansion in the same level in Australia, but Australia’s reserves is too good to go on tap.
So, what we are seeing the markets move down into to may be lower levels of profitability and more sustainable levels of profitability and I don’t see the government taxes really slowing that down all that much. I mean it may get little slow down in the interim as our customers go through negotiation and can't start up a new mine, while negotiating for lower tax rates. But fundamentally, over the long-term, we don’t see the tax levels that are being imposed to be unreasonable and not enough to destroy the economics and supply in the key markets reserve.
Rob McCarthy - Robert W. Baird
Thank you, Mike. For those of you would like continue your dialogue with the company, there will be brief breakout session here in this room, small table up in the front to your left.
Next up in this room is Illinois Tool Works in the north ball room Stanley Black and Decker in the state room Pool Corp and then (inaudible) Tower International.