Joy Global: Worth a Look Before the Mining Industry Recovers

Joy Global has seen its share price tank by approximately 15% this year. Even though the company's third-quarter results beat consensus estimates on earnings, investors continue to remain negative on its prospects. The reason behind this negativity is the decline in earnings, revenue, and order backlog that the company has witnessed.

Joy Global is a manufacturer and supplier of equipment for open cast and underground mining activities. It manufactures belt conveyors, drills, shuttle cars, flexible conveyor trains, long-wall shearers, crushers, and similar equipment. It also manufactures spare parts for its equipment for aftermarket sales.

One of the major problems that Joy faces in its end markets is oversupply. Last year, global consumption of coal grew 2% to 7.84 billion tons while production grew 3% to 7.88 billion tons, resulting in a surplus that led to a decline in price. Due to the lower prices, mines started putting off capital expenditures, and that hurt Joy.

Coal consumption growth in China is estimated to have slowed down to 4% year on year in 2012, down from 10% in 2011. An economic slowdown in the country has affected demand, and this has been one of headwinds for Joy because it has substantial exposure to China. Caterpillar , one Joy's competitors, is also facing trouble in China of late.

Caterpillar had to cut its full-year forecast in July on the back of weak mining equipment demand. However, Caterpillar did manage to find a silver lining in the results when management stated that sales in China, excluding acquisitions, grew 20% year over year. Management also believes that "China has bottomed" and that given the cyclical nature of the mining industry, it should pick up again in the long run.

The tailwinds
The global mining equipment market is expected to reach $117 billion by 2018 at a CAGR of 8.5% from 2012 to 2018. Surface mining equipment holds the largest share of this market at nearly 37%, followed by underground mining equipment. The Asia-Pacific region is projected to be the fastest-growing area in the coming years, fueled by increasing mining production and related machinery sales in India, China, and Indonesia.

Coal's share of the global energy mix continues to rise. By 2017, coal will come close to surpassing oil as the world's top energy source according to the International Energy Agency. In fact, the world will burn around 1.2 billion more tonnes of coal per year by 2017 compared to today, equivalent to the current coal consumption of Russia and the U.S. combined. China and India will lead the growth in coal consumption over the next five years.

source: EIA

In addition, domestic consumption of coal in the U.S. is also expected to rise due to an increase in natural gas prices. The reduction of the U.S. stockpile to the five-year average is encouraging as we can expect to see an increase in coal mining activity. Coal production is expected to grow further in 2014, by an estimated 3%, as inventories stabilize and coal consumption increases.

Ninety percent of coal in the U.S. is used to produce electricity. The entire coal sector enjoyed an upgrade by Moody's, which believes that electricity demand could rise and pull prices higher. This has been a driver behind Arch Coal and Alpha Natural Resources as well. The increase in domestic mining activity augurs well for Joy and other mining equipment suppliers; once the activity in the mining industry picks up, one can expect an increase in capital expenditure.

As an example, Arch Coal recently reduced its capital expenditure forecast by $20 million for fiscal 2013. The company's capex forecast for 2013 is now between $280 million and $310 million after the reduction. However, Arch Coal management believes that the current weakness in the coal market isn't sustainable.

Arch Coal stated that global crude steel production is expected to increase 35% between 2012 and 2020. The expansion of steel capacity will lead to higher demand for metallurgical coal since steel production from iron ore needs coke, which is made from metallurgical-grade coking coal. Thus, an increase in metallurgical coal demand will also lead to more coal mining, which bodes well for the likes of Joy Global.

Is a recovery in sight?
In the open-cast mining sector involving iron ore, there are conflicting analysts' opinions regarding growth projections. Oversupply is the main reason behind the decline of ore prices. Australia, the largest iron ore exporter, forecasts exports to rise 14% in the ongoing fiscal year. Weakness in pricing is in the cards next year due to slower than expected economic growth in China, however.

The economic recovery in major commodity markets will take time. As a result, growth in commodity demand will be slow. The cut in capital expenditure by the mining industry in general is another indicator that the recovery will be slow.

Signs of a slow recovery are very much visible in the guidance of Joy Global as well. The results display strong operational efficiencies and weak market conditions, but the company likely won't see light at the end of tunnel until late 2014.

It's not game over for Joy. The company has a good track record of revenue growth and has a low debt-to-equity ratio. It still has the aftermarket segment which can generate more business as the need for replacement parts will go up due to aging equipment. It has also announced a share repurchase to the tune of $1 billion over the next three years.

If the recovery in the mining industry -- driven by higher steel production and an uptick in China -- indeed happens as expected, then Joy Global should witness better times. And under eight times its earnings, the stock is dirt cheap when compared to others, such as Caterpillar (which trades at 14 times earnings.) That's why value investors should definitely take a look at Joy Global.

Skeptical About Future Growth?
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