To its credit, Joy Global (NYSE:JOY) has done nothing during this cyclical mining equipment decline to shake investor confidence in the quality of the company or its management. Margins have held up surprisingly well, and new product development could help compensate for some of the weakness in the market. What's more, I don't think there's much doubt that coal demand will continue to increase around the world for at least the next decade or two. The question for investors, though, is the timing and magnitude of the upturn in equipment demand and how much of that is already incorporated into the shares.
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All Things Considered, A Decent Quarter
This wasn't the sort of quarterly report that Joy Global management will print out and frame for the office wall, but it was a solid quarter all the same given the conditions in the market. Relative to other players in the market like Caterpillar (NYSE: CAT), Komatsu (OTC:KMTUY), and Atlas Copco (OTC:ATLKY), I'd argue that Joy Global is doing a darn fine job of holding its own.
Revenue fell 12% this quarter (relative to last year), but rose 18% on a sequential basis. Both the Underground and Surface businesses saw mid-to-high teens sequential growth, while the former fell 23% from the prior year and the latter was actually up 3%.
I continue to be impressed at how well Joy Global is maintaining margins through this downturn. Gross margin actually rose on both an annual (up 10bp) and sequential (up 40bp) basis. Operating income fell 16% from the year-ago period (and rose 26% sequentially), but fared well relative to sell-side expectations.
SEE: Understanding The Income Statement
Outlook Still Bleak, But This Isn't News
Joy Global revised its guidance lower with this report. While the new guidance is lower than where the Street was before (at least with respect to published estimates), I struggle to call this a real surprise.
Coal production in China is still down by double-digits on a year-over-year basis, and even with the recent improvements in U.S. utility inventories of coal it's not as though the U.S. coal sector is close to a healthy state. To that end, the 8% year-on-year decline in bookings is probably stronger than the underlying market really supports (and management said it was boosted by a large longwall order in the U.S.).
Joy Global is managing this downturn as well as can be expected, and the introduction of new products like a hybrid shovel and a surface ore loading system will help cushion some of the downside. But the reality is still that large coal producers like Consol (NYSE:CNX), Alpha Natural Resources (NYSE:ANR), and Arch Coal (NYSE:ACI) are all looking to spend less on coal capex this year (ranging from 10% to 50% less), and they're frankly highlighting lower capex spending as a positive to Street analysts worried about their capital structures during the downturn.
IMM Controversy More About Image Than Money Now
Joy Global has also seen some concerns raised again about its Chinese business IMM. As Caterpillar has had to acknowledge that its large Chinese purchase was largely a fraud, so too have some accused IMM of being a company with serious fraud issues (including allegations that the company set up shell company “customers” to inflate numbers).
Joy Global has investigated the matter (as has its auditor Ernst & Young) and maintains that these concerns are unfounded. Nevertheless, IMM's results are running about one-third below plan, so I can understand the concern. While I don't think it would be all that damaging to Joy Global's financials if serious accounting problems at IMM were to come to light, the damage to the company's reputation with investors could be more substantial. Either way, with about half of the world's coal production occurring in China, Joy Global has to figure out how to get the IMM business going again.
The Bottom Line
Buying into such an ugly coal market takes a fair bit of courage, but I do believe coal demand will eventually recover and with it, demand for Joy Global's equipment. I also believe that M&A rumors will keep things interesting – whether it's rumors of a company like General Electric (NYSE:GE) or Komatsu buying Joy (which Komatsu has considered and declined in the past), or Joy Global trying to acquire parts of Atlas Copco or Sandvik to create an even more integrated mining equipment vendor.
SEE: Analyzing An Acquisition Announcement
The U.S. Energy Information Administration projects long-term coal production growth of less than 1% for the U.S., while the International Energy Agency is looking for global growth of 3% to 4%. With that, a long-term revenue growth estimate a bit above 2% doesn't seem unreasonable for Joy Global, with better margins and cash conversion leading to better free cash flow growth as well. All told, I can see an argument for Joy Global trading above $60 today, investors considering these shares should expect volatility over the next 12-18 months.
At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.
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