What's Good For Miners Now Is Bad For Mining Equipment Makers

What's Good For Miners Now Is Bad For Mining Equipment Makers

In its second quarter analyst meeting, BHP Billiton noted that demand for mining equipment is low, which generally precedes reduced supply. This is another good sign for currently struggling miners like BHP, but a bad thing for companies like Joy Global and Caterpillar .

A bad year for a good company

BHP reported weak fiscal 2013 results, with the top line falling about 9% and the bottom line plummeting nearly 30% compared to fiscal 2012. Weak iron ore, coal, and copper prices were the main drags. That said, the financially strong company, where debt makes up just about 30% of the capital structure, has continued to invest and was able to increase production at these businesses.

Moreover, BHP has refocused around cost savings. In addition to focusing spending on only the most advantageous projects, thus reducing its overall capital spending, it is also working to reduce costs and increase efficiency at existing operations. For example, cost containment actions taken at the company's Queensland metallurgical coal facility have returned that facility to profitability despite the particularly difficult met coal market right now.

Although a U.S. government inquiry into the company's business practices is a concern that investors need to watch, BHP is a relatively low risk option in the mining space. For example, even though fiscal 2013 was a bad year, the company still earned around $2 a share. As supply and demand get back in line, BHP's ability to keep investing through the ebb of the business cycle will set it up for solid long-term performance when pricing improves.

More troubled
The industry wide trend toward reducing costs and, for companies with less financial strength, reducing production, however, is bad news for mining equipment companies. That trend has clearly shown up at two big players in the space. Caterpillar, for example, reported second quarter earnings that were down over 40% compared to 2012. The biggest impact came from a an over 30% drop in sales within the company's Resource Industries segment—in other words, miners.

And it doesn't look like things will get any better. The company expects industry wide spending in the mining industry to be down between 5% and 10% this year and as much as 20% next year. This segment is likely to remain a drag on earnings. Notably, the company lowered its earnings guidance for 2013.

Although Caterpillar is a good company, and the shares are off about 15% from their highs earlier in the year, the around 2.9% yield isn't high enough to warrant sticking around through the current rough spot. Investors should wait for a better entry point.

Less Joy than 2012
Joy Global, saw a bottom line decline of over 15% in its fiscal second quarter followed up by an over 5% decline in the fiscal third quarter. The biggest hit came from declining sales of underground mining equipment. And at the end of the third quarter, the company's backlogs for both surface and underground mining equipment were down nearly 30% and over 40%, respectively, over the year ago period.

Looking longer term, the company's internal tracking of "major projects" shows that there's been a 40% to 50% drop in capital spending in the industries it serves. That's bad for Joy Global's outlook and led management to lower its guidance for fiscal 2013 and highlight that "improvement in the prospect list is not expected to have a significant impact on our 2014 order rate." In other words, 2014 should be a tough year, too.

The shares are down some 20% from highs reached early in 2012 and yield around 1.4%. Like Caterpillar, the company isn't paying investors well enough to stick around through this rough patch. Investors should look elsewhere until new orders pick up materially.

Bad news and good news
For Caterpillar and Joy Global the equipment sales slow down is bad news. Until their end markets start to pick up, sales are going to remain hard to come by. That said, a reduction in demand for mining equipment is a good sign for miners since it indicates that supply is likely to start tapering off. Financially strong miners like BHP, which can continue to invest even through tough markets, will be the ultimate beneficiaries. However, as performance improves at companies like BHP, investors should take a second look at mining equipment makers.

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The article What's Good For Miners Now Is Bad For Mining Equipment Makers originally appeared on Fool.com.

Reuben Brewer has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Originally published