In our earlier thesis, we discussed General Electric (GE) in detail, and concluded that it is a story of rising operating margins and revenues. The recent announcement of GE going big in the mining sector has sent bullish signals to the market. Investors have been baffled, as the announcement has come at a time when the giants of the mining world like Caterpillar (CAT) and BHP Billiton (BHP) are bearish on the market. GE Mining, which it will be called in the future, is currently a part of GE Transportation, and had generated $2 billion in revenues last year. The new division is expected to make $5 billion by 2016 through strategic acquisitions.
What Others Have to Say?
The idea was presented by GE in MINExpo two days back. It came as a surprise, since analysts had been bearish on the Mining Industry as a whole. CAT, considered the barometer of global mining and construction activity, slashed its EPS outlook from $15-$20 to $12-$18 in 2015, given the slowdown in the global economic environment.
Companies that produce equipment for mining, like CAT and Joy Global (JOY), are pure plays on the mining CAPEX in their target regions. The JPM analyst claims that the mining cycle is currently at its peak, with $136 billion of industry CAPEX. It is expected to fall by 14% by 2014.
Out of eight of the largest mining players in the world, only three have announced that they will increase their spending this year. Vale S.A. (VALE) has announced to cuts spending by 4%. The outlook from Australia and China is not good as well. Sales of excavators have been down in China by 40%. The Australian iron-ore producer, Fortescue Metal Group, also slashed its annual spending for the year by 26%.
Joy Global is one of the only few who are optimistic about the global mining sector. Mike Sutherlin, in the latest earnings release, claimed that Chinese mining had bottomed and was ready to rebound.
What will GE do?
Lorenzo Simonelli, the CEO of GE Transportation, under which the current GE Mining operates, is not as bearish as others. He acknowledges that there is short-term volatility, but he believes that in the long-run, the industry will remain there forever.
GE Mining already offers water desalination systems and electric engines to mining companies. GE plans to build up GE Mining with the help of small tactical acquisitions of mining manufacturers. It has already acquired Industrea Ltd and Fairchild International, for this very purpose. Most analysts believe that GE's strategy of acquiring rather than building on its own is a much better option. However, they are of the point of view that GE should go with one major acquisition, rather than several small acquisitions, if it wants to see GE Mining expand at a quick pace.
GE Mining's CEO has a different way of seeing things, as he thinks that smaller acquisitions will be much easier to assimilate into GE Mining, rather than large buys. However, he says that GE will still consider larger acquisitions if required. Even GE CEO Jeffrey Immelt has said that he is looking for acquisitions to be between the $1-$3 billion range.
The market has not forgotten GE's tactics of expanding into the market by acquisitions. The company expanded its oil and gas division by acquiring Dresser, an oil-field equipment manufacturer, and the John Wood Group for $3 billion and $2.8 billion respectively.
In case GE goes for bigger acquisitions, Joy Global or Weir Group Plc, the U.K.-based manufacturer of mining equipment, are the main targets.
Joy Global is a very lucrative option for GE, as the company recently made operating margins of 21.2%, double the industry's average (10.6%). The $5.8 billion company is trading at cheap valuations. The company made $4.4 billion in revenues last year, and is trading at a forward P/E of 8x, which is less than 91% of the group with companies worth $1-$10 billion. In our earlier thesis on Joy Global, we mentioned that Joy makes electric shovels, and GE makes its engines; therefore, an acquisition of Joy by GE makes a lot of sense.
Weir, the $6.2 billion company, is also trading at cheap valuation, as its multiple of 12x is less than industry's average of 20x.
In the smaller companies, Boart Longyear Limited, the Australian manufacturer of drilling equipment, is an attractive buy. The $786 million company trades at a multiple of 4.2x, which is the third lowest in its industry.
Acquisitions in the Mining Industry accelerated this year. Around $4.15 billion worth of acquisitions were reported in this industry, which is up 51% YoY. However, many of them have been targeted to achieve increased market shares in order to sustain revenue growth, as industry sales declined globally. However, GE Mining is set to expand not because it's a question of survival, but because GE's management believes there is a huge opportunity in this field in the long-run, from which GE can benefit.
GE is a story of increasing margins. It topped all last four of its revenue and EPS estimates. The company is making positive cash flows. With an improved financial arm i.e. GE Capital, the company's capacity of making acquisition deals has improved. The expansion of GE Mining will definitely benefit the stock, and will help GE reduce its reliance on GE Capital. Although investors may be wary of the risk associated with this expansion due to a weak global economy, we expect that acquisitions in the near future will not be poorly timed when considered from a long-run perspective.
GE pays a hefty dividend yield of 3% as well.