Joy Global Surprised By China But Remains Wary of "Bumping Along the Bottom"
By Dr. Duru written for One-Twenty
September 03, 2009
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As usual, mining equipment manufacturer Joy Global (JOYG) provided revealing commentary on global commodity markets and economic conditions (read latest earnings report or listen to full conference call). JOYG has been surprised at the on-going strength of China's consumption of commodities. In its previous earnings conference call, JOYG cast doubts on the sustainability of Chinese demand, particularly in copper. This time around, President and CEO Michael Sutherlin was particularly impressed with the economic activity in China: "...although we previously thought we could see a drop in imports as stockpiling reached an end...there is enough momentum in the Chinese economy to allow the correction of large stockpiles of commodities to be achieved through moderating growth rates rather than import declines." In other words, imports of commodities will remain robust but will not grow as fast as the current pace. The earnings report contains some specifics:
"China's growth comes from an effective stimulus program and relaxed credit restrictions. This has lead to strong imports of all commodities. Imports of met and thermal coal, copper and iron ore continue to run at high, and often, record levels. Iron ore imports are up almost 50 percent and metallurgical coal imports are three times that of last year. Copper prices have doubled from their lows last December on the back of almost 70 percent increase in China imports. These import levels are higher than China's industrial production rates, and stock levels have increased. Some of the stock building has been in anticipation of stimulus spending, and some is the result of China's historical pattern of opportunistic re-stocking."
JOYG also noted surprisingly strong growth outside of China: "Growth in ...India was above expectations. It was a surprise that Germany, France and Japan reported positive growth in the second quarter." However, conditions in the United States keep JOYG wary of "bumping along the bottom" of an economic recovery: "In summary, the international commodity markets have improved faster than expected and should remain strong for at least the next couple of years. The U.S. coal market has seen a steeper demand decline and additionally will have a delayed response to improved demand as it works off higher than normal stockpiles. As such, recovery in the U.S. market may be a year or more behind the international markets." Industrial production in the U.S. remains weak: "Industrial production in the U.S. dropped to 65 percent utilization as companies focused on improving cash flow by reducing inventory levels. Steel inventories have been reduced to volumes not seen since the early 1980's and in months of supply, to below the average of the last ten years..." Copper remains a great example of the contrast between China and the rest of the world. Sutherlin noted that there is very little demand for copper from other major industrialized countries (he did translate this differential to mean that copper has the most upside potential of the commodities).
This uneven mix of economic activity - a strong China, weak U.S., and firming elsewhere - keeps JOYG cautious: "It is too soon to determine whether this will lead to recovery or is the start of a period of bumping along the bottom. We continue to look to the activities and decisions of our customers as the best indicator of future trends and directions for our business, and they continue to be cautious as well. After suffering the pain of delaying approved projects and cutting production, our international customers are waiting for clearer signs of sustainable recovery in the global economy before undertaking the expensive and lengthy process of restarting any projects or adding back production."
JOYG translated its caution to its backlog. The company reduced its backlog by a whopping $606 million to meet its more stringent criteria for booking orders as backlog. (The backlog is now $1.8B). Previously, JOYG only required a letter of intent (LOI) and a deposit in order to keep up with the fast pace of orders. As customers have been forced to delay projects, JOYG now requires progress payments for orders in backlog. JOYG still expects these delayed projects to resume but this change represents a new business/execution risk - even as JOYG re-affirmed its revenue guidance for the year and increased earnings guidance thanks to cost-cutting and efficiencies. JOYG still plans to downsize the business to prepare for reduced activity in 2010.
An analyst asked the quarterly question regarding buybacks. Sutherlin indicated that the company has no plans for buybacks - meaning that last year's announced buyback remains on indefinite hold. I was surprised that no one asked about potential stock offerings. During the last conference call, Sutherlin mentioned that JOYG would consider an offering if the stock price continued to increase. JOYG should note that the benign environment for stock offerings may be ending soon as the stock market has already absorbed record amounts of insider sales and stock issuance.
As of writing, JOYG's stock has returned to the same price from the last conference call. Thanks to the small bump up in earnings guidance, JOYG's forward P/E has gone down from 17 to 16. I still consider this too high for the recognized risks in the business. A 12 forward P/E seems more appropriate, pegging JOYG at $28 (which just happens to be around the 200-day moving average of price). Investors who are a lot more optimistic/bullish will likely find JOYG's current multiple extremely attractive.
Be careful out there!
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