According to Bloomberg, industrial conglomerate GE (GE) is considering purchasing mining equipment maker Joy Global (JOY). Given the generally negative macroeconomic sentiment and bearish outlook on important global economies such as China, we think Joy Global's recent price decline could make it an attractive takeover candidate as GE looks to build its mining equipment business.
Though the near-term picture looks murky at best, we like the long-term dynamics of mining suppliers. We think the equipment providers are less sensitive to pricing than the miners themselves -- as long as miners can make money selling resources, they will have to purchase mining equipment. However, as we've seen from our Best Ideas Newsletter holding Rio Tinto (RIO), spot prices can fluctuate wildly, materially impacting earnings. Please click here for our valuation of RIO.
It goes without saying that mining equipment firms perform better when spot prices are higher, but demand and expectations for future orders are more relevant for the equipment makers. Given the bullishness we've seen from Rio with regards to future demand in China and India, we're comfortable that basic materials demand, especially for iron ore, will continue to rise over the next several decades.
Currently, the sentiment regarding economic growth, as well as mining demand, is overly pessimistic since the developed world remains mired with heavy debt burdens and deleveraging. This has led to a precipitous decline in capital expenditures from the miners and declining earnings for Joy Global and Bucyrus, owned by Caterpillar (CAT) -- click here for our valuation of CAT.
We'd love for GE to acquire mining equipment firms while prices are reasonable and sentiment is negative. GE currently makes a variety of industrial equipment, including complex turbine engines, but we think it would be easier for the firm to gain a market presence via acquisitions rather than organic expansion, since the equipment makers already have customers and manufacturing infrastructure. In the make-versus-buy decision, buying seems like the better, higher return-on-investment route.
Joy Global currently trades at the low end of our fair value range, but we think a sale would require a decent sized premium to its current market price (likely at or around our point fair value estimate). Too view how we calculate the intrinsic value of Joy Global and other firms in our coverage universe, please click here. Price is paramount to any acquisition's return, but we suspect the conglomerate could find some synergies and cost savings with any acquisition (especially in manufacturing equipment). It is also interesting to note that while companies like Kraft (KFT), Tyco (TYC), and ConocoPhillips (COP) have spun off parts so they can be separately valued, GE seems content to expand its product reach.
Though we view a possible take out of Joy Global and its valuation as interesting (shares are trading at the low end of our fair value range), we're not rushing to add more mining-derivative exposure to our Best Ideas portfolio at this time. On the other hand, we like GE's dividend and its payout growth possibilities (even after acquisitive activity), and we are strongly considering adding the industrial conglomerate's shares to the portfolio of our Dividend Growth Newsletter at this time.
Additional disclosure: RIO is included in the portfolio of our Best Ideas Newsletter.