Today From Barron's
The Joy of Mining
By Vito J. Racanelli |Published: April 26, 2007
AFTER THE MINERS trudged home from the great California Gold Rush of
1849, most of them empty-handed, history recorded this now-hoary saying: The
folks that got rich on gold were the ones selling the picks and shovels. Joy
Global (JOYG: 52.01, +0.73, +1.4%) makes today's mining equipment:
monster-sized, above-ground shovels, and the toothy continuous-mining machines
used below. And strong global economic growth, especially from China, keeps
increasing demand for minerals more mundane than gold like coal, copper and
iron ore creating a lot of business for Joy Global. Yet shares of the world's
biggest mining-equipment firm aren't participating in the roaring commodity
rally.
The main culprit? An overreaction to soft coal prices brought on by an
overbuild of inventory after intermittent spells of warm winter weather. As
important as some coal customers are for Joy Global, coal is far from the whole
story, and investors should take a closer look at this chance to buy a quality
company on sale.
The Milwaukee-based outfit's shares have dropped markedly, from a high of
about 72 in April 2006, to around 47. Yet the firm is likely to profit nicely
from a number of sustainable global-growth trends that will drive the stock
higher perhaps by 30% or more over the next couple of years as the coal fears
recede, according to a number of savvy institutional investors who have been
loading up on the shares during the downdraft.
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Another plus: The stock now sells at a low valuation, relative to its
expected double-digit sales and earnings growth over the next few years.
Furthermore, in an industry with very high barriers to entry, it has about a
60% market share and relatively low debt. And despite already strong 18%
operating profit margins, there's room for improvement, they say.
Since the middle of 2006, investors have fretted about U.S. coal prices,
which have dropped as inventories of the stuff have risen on two
warmer-than-expected winters. That, in turn, forced U.S. coal miners the
source of 40% to 45% of Joy Global's revenue, of which two-thirds comes from
the underground-mining business to reduce their formerly strong capital
spending.
As well, U.S. electricity demand, half of it supplied by coal-fired
generators, was little changed in '06, a highly unusual occurrence.
Then came Joy's flattish results for its January-ended fiscal first quarter,
when sales and earnings per share inched up, respectively, to $560 million and
51 cents per share from $553 million and 48 cents. Yet the market focused on
the 22% drop in underground-mining equipment sales again, thanks to a soft
U.S. coal market and the stock dropped accordingly.
However, North American weather should at some point soon revert to the mean,
with the return of colder winters. Exceptionally warm winters "are outliers,"
contends Chris Armbruster, an analyst at Al Frank Asset Management, who thinks
Joy Global's shares are undervalued.
The company has two divisions: 40% of revenues come from P&H Mining, which
produces surface machines, like shovels; the remainder are generated by Joy
Mining, which makes subsurface gear.
Despite the sharp drop in Joy Global's U.S. underground-coal-equipment orders
in the first quarter, Joy Global's other businesses were strong enough to
overcome that, Armbruster adds. At some point, the weather will normalize, says
the analyst, whose institution bought shares recently.
In addition, the flatlining of demand for electricity in the U.S. last year
marked just the fourth time that's happened in the last half century.
And with the ongoing rise in use of computers, air conditioning, cellphones
and the sundry other electronic gadgets, investors should ask themselves how
likely it is that demand will continue to languish.
There are early indications that things are already turning around. Joy
Global CEO Michael Sutherlin says U.S. electric demand is up 5% this year, and
coal production is flat. Meanwhile, coal inventories have dropped to 40 days'
supply from 50 days. Translation: Coal prices are likely to stabilize and start
to rise as 2007 progresses.
So will coal production. Indeed, prices of the black rock are already showing
signs of firming and inching up in various parts of the U.S., according to a
recent industry report from Merrill Lynch. Stocks of coal producers, by the
way, have started to respond, up about 20% this year, after falling some 25% in
the second half of 2006.
Joy Global garners more than 50% of its sales overseas, and will continue to
profit nicely from the huge growth seen in emerging-market economies like China
and South Africa, and Australia, too. In the October-ended fiscal 2006, for
example, emerging markets revenue was $307 million, double what it was just two
years before. The company also expects China alone to provide $500 million by
2010.
In fiscal 2006, Joy Global posted sales of $2.4 billion and earnings of $3.38
per share, up 25% and 180%, respectively, from 2005.
Because of strong demand for commodities, "our international customers
continue to make long term investments and commitments running out to
2010-2012," the CEO avers. With a large installed base of Joy Global machines
around the world, "we see continued growth in parts and service demand."
Meanwhile, the company's most recent guidance, he points out, is for $2.7
billion to $3 billion for the rolling 12 months ending January 2008 and $2.85
to $3.25 per share. But that doesn't assume a recovery in coal demand. By 2009
or 2010, the company's fans say it's likely to earn close to $4 a share in
profits.
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