Many words have already been written about the global slowdown in heavy equipment demand, and the consequences that has brought for well-known industrial names like Caterpillar (CAT), Deere (DE), Komatsu (OTCQB:KMTUY), and Cummins (CMI). For Joy Global (JOY), though, it's not just about a global slowdown in machinery orders, nor even a slowdown in mining equipment. Rather, the key question for Joy Global and investors over the next six to 18 months is whether 2012's dramatic slowdown in coal is a new normal or just another trough in a cyclical up-and-down story.
A Little Good News In Fiscal Q3, But You Have To Look For It
This was not a strong quarter for Joy Global. Expectations have been steadily eroding for months, but the company still missed the target for the quarter.
Revenue rose 22% as reported from last year, but organic growth was more on the order of 11%. Perhaps more relevant was the 10% sequential decline in revenue. Underground equipment sales rose 2% from last year, while surface equipment sales were much stronger at 22% growth. Interestingly, overall original equipment sales rose 15%, while aftermarket sales rose 7% - arguably underlying the increasing sluggishness in mining activity. IMM, the company's Chinese mining firm, saw sales decline more than 20% on a sequential basis.
If there's good news for Joy Global it can be found in the margin information. Gross margin did weaken a bit from last year (by about 60 basis points), but improved more than a point from the second quarter. Operating income grew 27% from last year, while falling 10% from the second quarter as a strong result in surface mining was compromised by weakness in the underground business. All this said, it has to be a little encouraging that Joy Global is maintaining respectable operating margins despite a relatively sudden decline in revenue.
Don't Look For A Quick Turn
There was little in Joy Global's commentary that should fuel expectations for a quick rebound. Bookings fell 12% from the second quarter, or 16% excluding LeTourneau. Management also lowered its revenue and profit expectations for the remainder of this fiscal year.
Now the question is when and if demand will come back. On that score, the outlook for Joy Global is a little worrisome.
Can King Coal Keep The Crown?
Unlike Caterpillar, Komatsu, and Atlas Copco (OTCPK:ATLKY), Joy Global is uncommonly exposed to the coal market, with upwards of two-thirds of its revenue coming from coal mining activity and a sizable chunk (about 25% of total sales) tied to U.S. coal mining. While I do believe that U.S. coal prices are likely to see an eventual recovery on the back of higher natural gas prices, the question of whether that's a 2013, 2014, or 2015 event matters quite a bit when it comes to modeling Joy's cash flow.
Likewise, I think the nature of Joy's business is apt to change - barring a reversal of environmental and worker safety rules and/or the introduction of automated technology, underground Appalachian coal mining looks like its on its way out, and Joy Global's competitive position isn't as strong in surface mining as it is underground.
The international outlook is certainly not helping matters either. China currently has a glut of coal in utility stockpiles, and that's leading coal companies with significant Australian operations (including Peabody (BTU)) to rein in expectations. Along similar lines, there has been a great deal of attention paid recently to major mining companies like BHP Billiton (BHP), Rio Tinto (RIO), and Anglo American pulling back on their project development and capital spending projections, as well as speculation in Australia as to whether the mining boom is over. While Joy Global does have less exposure to commodities like copper, iron, uranium, and so on, it's still not a positive development.
The Bottom Line
I don't yet accept the idea that mining machinery demand was a bubble. The average age of equipment like electric shovels across the global fleet is still measured in the double-digits and older equipment costs more to run in terms of maintenance and fuel. Consequently, I think the underlying demand is there, but the sudden jolt to the coal market may lead miners to be a little more cautious with future commitments, stretching out the recovery timeline.
I'm looking at roughly 4% annual revenue growth out through 2017, with some ongoing improvement in free cash flow conversion above the average of the past three fiscal years. With the company's significant debt, that leads to a fair value estimate in the $60s.
Admittedly that's well below current sell-side targets and could easily be conservative if coal-related equipment demand holds up as miners take a full-cycle view of their equipment needs. Along those lines, if you look instead at sell-side expectations, you'll find much higher sales growth and free cash flow generation expectations - enough to push a fair value target into the $80s.
Joy Global is not my favorite heavy equipment or mining idea right now. I like Komatsu and Atlas Copco better, and think a company like Titan International (TWI) is worth a look as well. But I won't deny that if natural gas prices can jump up to the $4.00/MMbtu or $4.50 level, investors will be a great deal more enthusiastic about this name.