Joy Global And The Coal Conundrum

By Stephen D. Simpson, CFA | December 14, 2012 AAA

While it's hardly news that investors have sold all manner of heavy industrial OEMs as 2012 has progressed, and Joy Global (NYSE:JOY) has been hit a litter harder than most. Without the offsetting construction or agriculture businesses of Caterpillar (NYSE:CAT) or Deere (NYSE:DE), or the industrial compressor business of Atlas Copco (OTC:ATLKY), Joy Global shares have had a tough year. Although this large mining concern ended its fiscal year on a relatively positive note and valuation is not particularly demanding, these shares figure to be more volatile than average as investors guess about the timing of the eventual coal recovery.

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Beating the Street to Close the Year
Even with all of the much-reported problems in the coal sector in the United States this year, Joy Global still closed the year on a strong note as residual business flowed through.

Revenue rose 19% from last year, with organic revenue growth of about 15% on an annual basis. Underground performance was definitely weaker (up 4%) on declines in Appalachian coal, while surface revenue increased 35%. Not too surprisingly, the China-focused IMM business saw a 25% sequential decline in revenue.

While Joy Global did seem to experience some diseconomies of scale, the overall operating performance wasn't bad. Gross margin did slip about 70 basis points (BPS) from last year and 120 BPS from the third quarter on a reported basis, while operating income rose 10% from the year-ago level. Margins were notably weak in the IMM unit, while surface equipment margins held up quite well (up 180 BPS from last year and down 10 BPS sequentially). Underground operating margin fell 240 BPS from last year and 110 BPS from the prior quarter.

SEE: Analyzing Operating Margins

A Quick Turn Seems Unlikely
I would characterize Joy Global's management as "cautious" with respect to guidance, but reasonably so. Bookings fell 9% on an organic year-over-year basis, or about 5% on a reported basis, with a particular weakness in underground mining machinery (down 10%). That works out to a 0.5 book-to-bill ratio, and the backlog fell about 21% from the same point last year (and 10% from the third quarter).

Relative to what investors have heard lately from Caterpillar, Atlas Copco and Boart Longyear (OTC:BOARF), it's hard to call anything in Joy Global's guidance surprising. Revenue guidance calls for a 10% decline next year, but it's a pretty small revision relative to where analysts were before this report. While the margin guidance implied that the lower EPS numbers is a little disappointing, it too is no real surprise given potential volume declines.

Investors are right to wonder just how quickly the coal markets might recover, as that is still the biggest determinant of Joy Global's demand and success. Recent increases in natural gas prices have helped the Powder River Basin and Illinois Basin coal producers, but a recovery in Appalachian coal seems less likely in the short term. What's more, large producers are likely to play it cautious with big order commitments, while smaller miners may not be able to get the financing they need to make big capex commitments.

SEE: A Primer On Coal

The Bottom Line
With General Electric (NYSE:GE) showing more interest in mining lately, it's hard to say that the game of musical chairs in the mining sector is over. I would be a little surprised to see GE have a go at Joy Global, but I also wouldn't completely dismiss it. Likewise, companies like Atlas Copco, Metso, Sandvik and Outotec could be looking at adjusting their exposure to mining either through acquisitions or disposals. Even if no further deals take place, I think Joy Global will recover, though there likely needs to be a multi-year adjustment to the new realities governing Appalachian coal mining in the U.S.

I'm somewhat ambivalent about Joy Global shares at these levels. While I do think the stock will recover in time, the uncertainty about coal demand in 2013, 2014 and 2015 could make this a turbulent holding. Accordingly, I'd probably look instead at Atlas Copco or Titan International (NYSE:TWI) right now.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

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