Someone Needs to Dig Out Joy Global (JOYG)

I prefer Bucryus (BUCY) out of the 2 main 'mining equipment' makers but Joy Global (JOYG) is a quality company absolutely being buried in this very tough market. This seems like an overreaction but in this shoot first, ask questions never environment you just lost 1/5th of your investment overnight.

Joy has a very detailed earnings report, worth the read but I am looking at 2 things - #1 gross margins because my belief has been that higher input costs (steel, oil derivatives) will cut into profits for equipment makers and #2 industry outlook.

Looking at gross margins this year - they came in at 27.2% versus a year ago 31.7%. So that signals trouble, unless you use the same logic people are using to drive up consumer discretionary stocks i.e. "hey that's backwards looking, if you look ahead as commodities drop that should no longer be an issue." Funny how the market "applies" logic to where it wants, and ignores it elsewhere. So producers in say foodstuffs will be fine because as commodities drop they have better margins, but it doesn't apply to Joy Global. The irony is great. Either way, I've been worried about all types of equipment makers due to inflation as I highlighted a while back in Deere (DE) as well. I actually warned on this issue during Joy's last earning report in May [May 29: Joy Global with Solid Results - But I'm Not as Bullish as Everyone Else] As usual I'm early to a trend but I wrote then...

Joy Global (JOYG) along with Bucyrus (BUCY) are the 2 main public companies in the US for pure plays on "mining equipment". While I expect demand to be strong, which will help both these companies revenues, I have turned cautious on these names due to rising input costs - essentially the same thesis I have for the agriculture equipment makers i.e. Deere (DE) [May 14: Deere Earnings - Why I'm Avoiding Equipment Stocks]. Simply put, just as the automotive companies are being destroyed by change in style to small cars AND steel prices (Ford announced yesterday it is cutting more white collar jobs as steel prices ramp, GM doing yet another round of restructuring announced today), the impact of higher input costs is beginning to be felt across the globe by producers. [May 17: WSJ - Fast Rising Steel Prices Set Back Big Projects] Now in some industries, such as automotive there are other issues so revenue is flat lining, but even in "great industries" like agriculture or mining equipment that are seeing stellar growth, it is coming at a cost. Lower profit margins.

So while the folks on Wall Street ignore this issue because all they rely on are "government figures" on inflation - we are talking about it, and have been talking about for a long while. This will put a serious crimp on profit margins, and thus when the market faces reality - create lower stock prices. How is it effecting even the most stellar groups? We saw a few weeks ago the story in Deere - as to Joy Global while revenue is surging look at their gross margins - a year ago this quarter they were 33.2%; this quarter? 26.4%. That is a massive reduction in 1 year. So in plain English it takes more revenue just to derive the same income if your margins are dying on the vine. Now again, the demand is SO strong in this industry since mining equipment is at a premium that much of this gross margin destruction is offset by a huge ramp in revenue, but for 95% of the world's industries, demand is nothing like mining equipment.

Some comments on the industry outlook since it affects many of our global growth names; specifically coal

• The Company continues to see strong demand for its equipment based on the fundamentals of commodity demand versus supply and customer investments in productivity and capacity expansion. This view is consistent across all geographies and all commodities that the Company serves. Although there has been recent softening in the prices of exchange-traded commodities, the spot prices for physical delivery continue to remain strong and stay significantly above comparable benchmark and contract prices.
• Worldwide demand for steel should continue to grow at 4-5% per year over the next five years, driven by the industrialization of the emerging markets. Demand in China and India should continue to grow near or into double-digit rates over this period. This growth exceeds the capacity of both iron ore and metallurgical coal producers. Benchmark prices for these commodities have roughly doubled and tripled, respectively, and are expected to rise further next year. As a result, the Company's customers are making significant investment to accelerate new capacity in these commodities.
• Seaborne traded thermal coal demand has been largely driven by the electrification of the emerging markets. Earlier this year, the Company saw evidence that supply was not meeting demand as stockpile levels depleted in China, India and South Africa. Stockpile levels in South Africa have improved at the expense of exports, but still remain at less than half the targeted levels. Thermal coal demand in China continues to exceed supply, resulting in stockpile levels staying below three days. Demand continues to grow in China, with 80 new generating plants scheduled to come on line this year. In response, China is reducing export licenses for the remainder of this year to about half the year ago level and has added a 10% tariff to thermal coal exports to further limit outflow from the country.
• Seaborne traded thermal coal supply is further exasperated by export restrictions from tradition coal exporting countries. Indonesia has halted exports by six of its coal producers. Australia is expanding its rail and port capacity, but significant relief is not expected before 2010. As a result, seaborne traded thermal coal continues to trade above its benchmark price and the supply deficit is expected to continue for several more years.
• The U.S. is the only coal producing region with upside capacity in the near term, and has become the swing supplier to the international market. Exports last year were 59 million tons and are running about 50% above last year through the first half of 2008 There are 29 new coal fueled power plants under construction in the U.S. Of this, 14 gigawatts will come on line by the end of 2009 and an additional 8 gigawatts will come on line by 2013, adding about 80 million tons of coal demand.

All these "facts" while "speculators" are demolishing coal stocks because, to them, coal is no different than crude oil. So let's review - crude has dropped 30% but coal has been nearly flat the past 2 months. But stocks in both groups should be demolished to the tune of 40-50% ... because after all potash = corn = copper = crude oil = coal = coffee = gold = iron. To HAL9000, it's all the same thing.

No position