Joy Global: Down, But Not Out

| About: Joy Global (JOY)

Summary

Competent and experienced management team will be able to guide Joy Global through one of the roughest times in the company’s history.

Financial health is well, given the current conditions in the commodities markets.

Negative outlook and pessimism have created a value-orientated market that will reward patience.

There has been no reprieve for Joy Global's (NYSE:JOY) shareholders over the past year. Shares have plummeted close to 75% over a one-year period. The massive sell-off in the mining industry can be attributed to the worry about a Chinese economic slowdown and more stringent regulations on coal in the United States and around the world. Over the course of this article, we'll examine some important factors to determine whether or not Joy Global has a course to recovery.

Management

The executive team for Joy Global is comprised of seasoned officers; some of whom started with the company, while others transitioned from respected companies in the industry. President and CEO Edward Doheny joined the company in 2006. Before becoming President and CEO, he was the COO of the underground business segment of Joy Global's operations. The rest of the management suite is as follows: James Sullivan (Executive VP and CFO), Sean Major (Executive VP and General Counsel), and Johannes Maritz (Executive VP and Human Resources). Since the start of their career at Joy Global, the executives have been exposed to the cyclical nature of the mining industry, and are keenly aware of the measures needed to keep the business operating as efficiently as possible.

Within the current environment, management has taken steps to preserve cash flow by cutting expenses. At the end of September 2015, the company planned to lay off 109 employees from its Milwaukee mining equipment facility by the end of November. During the 2015 earnings release on December 16, 2015, it was revealed that the dividend would be cut from 20 cents to a mere 1 cent per share. These steps, along with many other cost cutting measures including, but not limited to discontinuing products, ramping down production, and decreasing R&D costs, have allowed for more flexibility. In an 8-K filed on January 12, 2016, Joy Global announced that they had amended an article of the company's bylaws to allow the ability to remove directors without cause by affirmative vote of the majority of shareholders. While this may not benefit the average investor, there is some solace in knowing that the directors must act in accordance with the investor's best interest.

The Industry

The mining industry has been perplexing to follow throughout the last decade (2005-2015). The industry enjoyed unparalleled success on the back of the growing Chinese economy. Major companies, such as Joy Global, Caterpillar (NYSE:CAT), Terex (NYSE:TEX), and Komatsu (OTCPK:KMTUY) enjoyed record high stock prices and revenues up until the financial collapse of 2009. However, a precipitous drop in share prices did not deter investors from buying back. Within two years of the 2009 collapse, Joy Global hit a record high of $102.36 on April 4, 2011.

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Source: Yahoo! Finance

Currently, the industry has been hit hard by reduced mining CAPEX and an oversupplied commodities market. Commodity prices as a whole have been dropping. Many minerals and ores have reached record lows, as suppliers try to sell off material goods like coal, copper, and iron ore. New physical equipment has been in a stagnant state, as miners freeze operations which do not add to the bottom line. Miners are also prolonging the maintenance schedule of their equipment to cut costs even further. All of this amounts to an industry that is fragmented and paralyzed by an underwhelming Chinese economy. New regulations regarding greenhouse gas emissions on coal in the United States have not helped either. Due to the readily available supply of coal, coal has to compete with other energy sources that are vying to become the most energy efficient. The regulatory burden of decreasing greenhouse gas emissions provides foresight into how the future of the mining industry will look, as the pursuit for new energy sources intensifies.

With much of the industry operating mainly in China, the constant exchange rate fluctuations can have an adverse impact on overseas sales of products and services for U.S.-based companies. If the dollar appreciates relative to foreign currencies, foreign goods and services become cheaper, and demand for U.S. equipment falls. Assuming the exchange rate for the Chinese yuan favors the dollar, Chinese competitors would have a price advantage over U.S. companies that can be passed off to the end-customers in China. The unpredictable nature of the exchange rates significantly affects industries that rely on overseas sales.

With all the negative sentiment driving down the stock prices of mining equipment manufacturers, major economies around the world still rely on coal as their main energy source. As of 2012, China supplemented 66% of the country's energy consumption with coal. A more recent claim by China's National Energy Agency reports that in 2014 that number was reduced to 64.2%. India is also becoming increasingly reliant on coal with coal accounting for 44% of India's total energy consumption. Together, both China and India have been responsible for increasing the global coal trade by 98% from 2008-2013. Though there might be a push in the United States and around the world for more eco-friendly energy sources, coal is here to stay for at least a decade due to no cheap alternatives. China and India still have room to grow, and the need for a cheap energy source will only increase equipment demand for miners who are looking to satisfy that need.

Products and Services

Joy Global has two main business segments: Underground mining machinery and surface mining equipment. The underground mining machinery segment is comprised of heavy machinery, conveyor systems, and drills, which extract materials such as coal, salt, platinum, and other bedded resources. The surface mining equipment line features machines that are primarily used for open-pit mining operations, such as excavators, mining shovels, and loaders. Materials that can be acquired with the use of this equipment includes coal, copper, iron ore, gold, and other minerals.

In addition to the handful of equipment Joy Global offers, the company's main source of revenue continues to be its service centers. For both the underground and surface mining business segments, the company has service centers in main mining areas throughout the world. If equipment breaks, the service centers either repair or completely replace parts to get the machinery back up to standards. These service centers act as the intermediary between the company and customers, and serve an essential function by offering logistics and life cycle maintenance support for equipment.

It is important to understand the breakdown between the products and services revenue on a YoY basis. The chart below illustrates the difference between Joy Global's revenue from products and services:

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Source: Joy Global Inc. 10k (2010-2015)

Starting after the recession of 2009 when the mining boom was in full force, product sales came close to matching service sales. However, after 2012, the divide between the two segments started growing further apart every year. In 2015, Joy Global's product sales slumped to 26% of total revenue, while service sales reached 74%. The increasing divide between the product segment and service segment is an area of concern. New equipment sales not only provide additional revenue, but it allows Joy Global to continuously update their product line by investing more into R&D. When equipment sales drop, as they have for the past three years, R&D goes down, the product line shrinks, and the company becomes reliant on the service centers to maintain profitability. To be sustainable, new original equipment sales have to be as robust as the service centers.

Financial Health

For the 2015 fiscal year, Joy Global realized 68% of total revenue from sales outside the United States, and 58% of revenue from thermal and metallurgical coal-mining customers. The crippling over-supply of coal from both U.S. and Chinese miners have pushed the price of coal to its lowest level in 10 years ($53.37 per metric ton).

As a result of the market conditions, revenue declined 16% from $3.778 billion in 2014 to $3.172 billion in 2015. Combined with impairment costs of $1.338 billion, Joy Global took a net income loss of $1.178 billion for 2015. The backlog is roughly 25% of its prior level four years ago, and moreover, bookings are down 25% compared to fiscal year 2014. Cash on hand represented a mere 5% of all current assets in 2015, total assets declined by over $1.8 billion, and $1.4 billion was lost in shareholders' equity.

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Source: Joy Global Inc. 10k (2010-2015)

There is a glimmer of hope in the numbers. Joy Global's P/E rests at 6.34, which is far less than the industry average of 22.59. Price-to-book is also extremely low at 0.77. The current ratio improved from 2.22 in 2014, to 2.27 in 2015. During the fourth quarter, Joy Global redeemed the entire principal amount of $250 million on the 6.0% Senior Notes that were due in 2016. The short-term hit to cash and the unsecured revolving credit facility will reduce the interest expense and leverage for fiscal year 2016. At the end of 2015, there was $812 million available on the credit facility. Coupled with free cash flow of $284 million, an increase of $12 million from 2014, there is enough cash to work with while the market sorts itself out.

The Road Ahead

The issues that plague the commodity and oil industries are not going to be placated in the short term. Fear that the Chinese market is slowing down has some credence, but the slowdown has been exacerbated by the investors who continue to short stocks of companies in the industrial sector. There has been a continued over-supply of minerals and materials for the last year. As production ceases and CAPEX declines, the supply that currently overwhelms demand will soon be reversed. Commodities, like the overall market, are not immune to the effects of the business cycle. Although down, the commodities market will recover in due time. While the post-recession boom was one of the greatest in history, the momentum was bound to fade after a certain amount of time.

Joy Global has shown resiliency in the face of downward pressure from macroeconomic factors that have taken a toll on the global markets. Through the worst, Joy Global has kept their free cash flow and current asset value to a level that ensures they have the ability to survive through the downturn. Furthermore, the management team understands the necessary actions that must be taken to transition the company to a position of strength when a recovery begins. Even though there is a possibility for more downside in the short term, at a price of around $10-$11 the stock is a buy; with potential for enormous upside in the coming years. The amount of negativity that has been priced into Joy Global has made the stock a good bet for a long-term, value orientated investor at its current price.

Disclosure: I/we 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.