Presentations of different mining manufacturers in MINExpo this year gave a confused outlook for mining markets, as some companies like Caterpillar (CAT) were bearish on the industry, while others like General Electric (GE) were bullish, considering the current slowdown as a temporary one. Joy Global (JOY) was another company that was bullish on the industry. In our earlier thesis on Joy Global , we recommended to short the stock, as CEO Mike Sutherlin was overoptimistic about coal markets in the U.S. and China. Although the demand story remains the same, and we still believe that the coal market has not yet bottomed (from which Joy gets 60% of its revenues), the company has developed on other ends, which give a positive outlook for the stock. The addition of newer products in the product line, the stabilizing nature of Joy's aftermarket operations, the successful cost cutting One Joy Program, and Joy trading at its five-year low multiples make the stock an attractive buy. There is a lot of chatter (discussed in detail later in the article) regarding General Electric acquiring the company.
Joy Global at MINExpo
Joy manufactures underground mining and surface mining equipment. Currently, 57% of the sales come from the underground mining segment, whereas 43% of the sales come from the surface mining segment. The main reason why the market has been bearish on the stock is the declining coal demand. Our earlier thesis stated that the market had been wary of the fact that the decline in coal demand might be secular rather than cyclical, given the rapid pace at which people are switching from coal to natural gas solutions.
Companies' predictions at MINExpo differed with regards to the future of the Mining Industry. Caterpillar, considered as the barometer of global mining and the construction sector, slashed its EPS outlook by 25% for 2015. This was in line with the fact that different companies around the world have slashed their Mining CAPEX, or are delaying their projects. BHP Billiton (BHP), the world's largest mining company, recently delayed its Olympic Dam project. Similarly, Australian iron ore giant, Fortescue Metal (FSUMF.PK), also slashed its CAPEX by 26% for the year.
At the event, on a balance, companies were optimistic on commodities outside coal. Mike Sutherlin admitted that the current environment was just a pause, and the long-term growth story of the mining sector was still intact. He expects the mining CAPEX to fall by 5%-10% in 2013. He also expected that gold and copper offered short-term revenue growth. As far as coal is concerned, Joy expects a rise in demand of about 10 billion tons of thermal coal from China and India, which is expected to grow at a 4% CAGR till 2020. That will help Joy achieve 9% growth in revenues in its core business, and an overall increase of 14%.
Why we recommend Joy?
Given the rate at which Joy expects its revenues to expand, EPS for 2017 come out to be $15.27 (of course assuming that corporate expenses grow in line with sales), which means an earnings growth of almost 125% from the current period. Given Joy's target of achieving 23% return on sales, the predicted EPS rise will lead to a sales figure of almost $10 billion in 2017. Given that the sell-side expects flat-to-5% revenue growth for Joy in 2013, the company will have to make 20% growth in 2014 and 2015 in order to reach the $10 billion sales milestone. This seems quite unattainable, but Joy is still expected to reap some benefits from the rise in demand for coal from emerging markets.
The main reason why we are bullish on Joy is that the company has made necessary capacity adjustments, keeping in view the soft U.S. coal market. Under the One Joy Program, the company has addressed its cost part of the equation. In this program, the company is expected to benefit from cost savings through synergies of Surface and Underground businesses. The company is expected to save $50 million of SG&A by 2017.
New product development will also lead to incremental sales, as the company's decelerating base business is more than offset by new cash flows from the new product line. The incremental cash flows are expected to be $1 billion by 2017.
Joy has the world's largest and most extensive aftermarket service and support infrastructure amongst the underground mining equipment supplier. Currently, Joy is making more than 50% of its revenues from aftermarket operations. The stabilizing nature of aftermarket operations continues to support the company's profits and cash flow generation in a down cycle.
Joy is also a potential target company for General Electric, as the big conglomerate has decided to go big on the mining business. Operating under the name of GE Mining, the new segment is expected to make strategic acquisitions in order to achieve increased market share and sales. However, GE's CEO said that the company would look for small acquisitions within the range of $1-$3 billion, in which case, the $6 billion-worth Joy would not be an option to be considered. However, many experts on mining have given favorable views for GE's acquisition of Joy.
Joy is trading at its five-year low multiple of 8x. The -36% YTD performance of the stock shows to some extent that the stock has already been punished for the downturn in the coal market. The One Joy Program is expected to help the company improve its margins. The company has set a target of 23.5% margin and 30% ROIC in 2017. The current margin (21.5%) is already twice that of the industry average. Given the rising product range, improving margins, improving aftermarket operations, and being a potential target for GE Mining, the stock is recommended as a buy.