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Profit From a Chinese Recovery With Joy Global

By Chad Fraser on December 18, 2012

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China continues to be the world’s largest resource consumer. Right now, for example, the country consumes roughly 65 percent of the world’s annual iron ore output. It’s also the biggest coal consumer, burning roughly half of annual global production. About 70% of China’s energy consumption and 80% of its power production come from coal.

The country’s economy has slowed markedly this year, to an annualized rate of 7.4% in the third quarter from 9.1% a year ago. That has hurt commodity demand and weighed on prices. In September, iron ore—essential to steelmaking—fell to a three-year low of just $86.70 per metric ton, down from $180 a year ago. The metal has since rebounded to around $130.

Lower resource prices have, in turn, hurt mining companies’ profits and prompted them to hold off on new projects. In 2013, global mining-equipment supplier Joy Global (NYSE: JOY) sees miners’ capital expenses falling 10% to 15% from 2012 levels. That will make the company’s equipment—including draglines, power shovels and front-end loaders—a tougher sell.

As a result, Joy Global cut its 2013 guidance when it announced its latest quarterly results last week. In its 2013 fiscal year, Joy Global now says it expects to earn between $5.90 and $6.50 a share, the midpoint of which is about 13% lower than the $7.13 it earned in fiscal 2012. Revenue will likely come in between $4.9 billion to $5.2 billion, which is off by roughly 11%. That forecast also fell short of the consensus estimate of earnings of $6.73 a share on $5.21 billion of revenue.

LeTourneau Acquisition Is Starting to Pay Off for Joy Global

Joy Global operates through two divisions: Underground Mining Machinery and Surface Mining Equipment.

The company recently made two big acquisitions. In May 2011, it announced its $1.1-billion purchase of LeTourneau Technologies, a maker of drilling gear and earth-moving equipment, from Rowan Companies plc (NYSE: RDC). In the third quarter of 2012, Joy Global completed its acquisition of China-based International Mining Machinery Ltd. (IMM), which makes equipment for coal mining in that country.

In the quarter ended October 26, 2012, Joy’s sales rose 19%, to $1.6 billion from $1.3 billion a year earlier. Net income increased 23.3%, to $212.6 million, or $1.99 a share, from $172.3 million, or $1.62. Without one-time items, Joy Global earned $1.94 a share, up from $1.82 a year ago. The latest results topped the Street’s forecast of $1.91 a share in earnings on $1.42 billion of revenue.

However, order bookings, a sign of the company’s future sales, fell 5%, to $1.3 billion. Surface Mining orders declined 21.8%, to $530.8 million, as original equipment orders fell 47% compared to a record quarter last year. However, LeTourneau’s sales jumped 64.7%, partially offsetting that drop. IMM contributed $40.0 million of bookings. Sales at the Underground Mining business were up 0.8%.

The company ended the quarter with a backlog of $2.6 billion, down from $2.8 billion at the end of the previous quarter.

King Coal Is Far From Dead in Emerging Markets

Even though many commodities remain in surplus around the world, a number of longer-term trends point to sustained growth in demand, particularly in emerging markets like China. For example, in the U.S., coal demand is falling as more utilities switch to cleaner and cheaper natural gas. However, gas trades at much higher prices in many overseas markets, making conditions much more favorable for coal.

According to a recent Peabody Energy study quoted by The New York Times, global coal demand will rise to 8.9 billion tons by 2016 from 7.9 billion this year, with much of that increase—roughly 700 million tons worth—coming from China. By 2035, world coal demand will rise 50%, according to the World Coal Association.

India, too, is a heavy user of coal, which currently provides 55% of the country’s power needs.

“If you poke your head outside of the U.S., coal-fired plants are being built left and right,” William L. Burns, an energy analyst with New Orleans-based Johnson Rice, told The New York Times. “Coal is still the cheapest fuel source.”

Rising Chinese consumption should help support coal prices, which should increase demand for Joy’s products, particularly at IMM, which makes giant shearers that cut coal from the coal face. It also makes gear for tunneling and excavating.

Chinese Demand “Will Still Be Substantial”

Moreover, the country’s economy is starting to show signs of recovery. The Chinese purchasing managers’ index (PMI), a key indicator of manufacturing activity, came in at 50.9 for November, its third straight month above 50 (which separates growth from contraction) and its highest level in 14 months.

Moreover, China’s inflation rate is decreasing, which gives the country’s central bank more options to spur growth, such as lowering interest rates. That would further support manufacturing activity and commodity consumption. As well, in September, the government approved 60 infrastructure projects worth a total of 1 trillion yuan ($157 billion US).

In addition, longer-term trends, such as China’s ongoing shift to an urban economy from an agrarian one, and its focus on building up its manufacturing capacity, should support resource—and mining equipment—demand. Global miners like Rio Tinto (NYSE: RIO) continue to be bullish on the country’s long-term prospects.

“While we should not expect demand to grow at the blistering pace we have seen over the last decade, nevertheless growth in demand will still be substantial,” Ian Bauert, the company’s managing director for China, recently said.

Joy Global’s strong balance sheet will help it weather the ongoing global slowdown: its long-term debt is a reasonable $1.3 billion; it ended the quarter with cash reserves of $263 million.

The stock trades at 8.50 times the company’s last 12 months of earnings, which is better than competitors Caterpillar (NYSE: CAT), at 9.18, and Deere & Co. (NYSE: DE), at 11.31. Joy’s quarterly dividend of $0.17 a share yields 1.15%.

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