This Mining Equipment Stock Is Set to Rally

Anindya is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Joy Global (NYSE: JOY) recently announced its quarterly results. The company reported $1.31 earnings per share (EPS) for the previous quarter, beating the Thomson Reuters consensus estimate of $1.14 EPS by $0.17. The company had revenue of $1.15 billion for the quarter, compared to the consensus estimate of $1.08 billion. During the same quarter in the prior year, the company posted $1.33 earnings per share. The company's quarterly revenue was up 1.2% year over year.

Joy Global manufactures and markets mining equipment used to extract coal, copper, and iron ore. Commodity prices directly impact the demand for Joy Global's products and services. The company primarily sells two types of mining equipment -- underground and surface.

Joy Global competes with its peers on the basis of price, quality, delivery and service. The company mainly competes with Caterpillar (NYSE: CAT) and Terex (NYSE: TEX). In this post, I will explain why Joy appears to be tremendously undervalued relative to its peers.

Equipment and Machinery Sector Outlook

The world economy is expected to grow roughly 3.9% in 2013, according to the World Economic Outlook published by IMF. Growth in advanced economies is projected at 1.9% in 2013, while it is anticipated that the emerging and developing countries would grow by 5.9% in 2013. 

Demand for the machinery industry is correlated with increasing economic activity, which stimulates demand for industrial products, thereby increasing the need for new/advanced machinery. The major end-markets for the machinery industry include agriculture, construction, mining and energy industries, among others. 

The machinery sector has been doing reasonably well during the economic recovery. While momentum seems to be flagging a bit recently, the group's growth performance has been one of the best in the economy, according to IMF. 

Growth Catalysts for Joy Global

While U.S. fiscal policy was an overhang on the fourth quarter, many other indicators provided encouraging signs for the U.S. economy as 2013 began, including improving labor statistics, strengthening industrial production and recovering residential and non-residential construction.

The Chinese economy is reporting that year over year growth is now improving in numerous key measures, and this has positive implications for global growth. Joy estimates that the Chinese infrastructure needs is going to be enormous in the next few years.

After the share of power generation from coal dropped to a low of 32% in April of 2012, coal generated 42% of U.S. electricity in November. This trend of natural gas to coal switching is likely to continue in 2013.

As the major stakeholder (about 60%) of the metals market, the steel industry was severely bruised by the global economic downturn. Recovery, however, has been swift and forceful. According to the World Steel Association, with global steel demand expected to increase further in 2013, steel mills have begun to replenish depleted inventories of metallurgical coal and iron ore, which has provided further support to prices.

Copper is a major industrial metal, with its price strongly correlated with the outlook for economic growth. Refined copper was in supply deficit by approximately 250,000 tones for the year 2012. In 2013, completion of several mine expansions should increase mine supply, reducing the deficit.

Joy’s Shorter Term Guidance Encouraging amid Slowdown Fear

Although most industrial company CEOs seem to think that we've seen the worst of the industrial slowdown, industry leader Caterpillar lowered revenue and earnings guidance on global slowdown fears. Caterpillar reduced its 2015 sales and earnings targets. It now believes it can achieve $12-$18 in EPS on $80 billion-$100 billion in sales in 2015 compared to $15-$20 EPS, previously.

The key difference is slower global economic growth driving a slower recovery in end market sales; Caterpillar is more convinced it will be more profitable going forward. The company also indicated that if global growth turns out to be closer to previous forecasts, it would raise its 2015 target back to $15-$20.

Another player in the sector, Terex is looking for 2015 revenue of $10 billion -- 37% higher than 2012's result, and just above the company's prior peak in 2008 (though that peak didn't include Demag). That number is going to be a tough target to reach, and Wall Street isn't buying it -- the average estimate for 2015 right now is about $8.9 billion.

Joy Global said it was comfortable with "previous guidance of earnings per fully diluted share between $5.75 and $6.35 on revenues of $4.9 billion to $5.2 billion, including $25 million of planned restructuring charges in 2013 with resulting savings not realized until 2014." However, Joy's management didn’t speak about its longer-term revenue outlook.

Joy Undervalued Relative to Peers

Joy’s revenue per share is rising at a stunning 105% rate, while for Caterpillar, it’s rising by only 30%, and for Terex, it’s negative.

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JOY Revenue Per Share TTM data by YCharts

Joy’s ROIC (return on invested capital) currently stands at 19.32%, compared to Caterpillar’s 13.45% and Terex’s 2.46%. Clearly, Joy is enjoying a significantly higher economic moat than peers, along with an impressive revenue growth.

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JOY Return on Invested Capital data by YCharts

When Terex announced earnings a few days ago, the company disappointed the Street. Although the outlook and long-range guidance were still pretty positive, the company missed from the revenue line on down through the income statement. Revenue fell 13% in the period. Construction equipment led the way with a 35% decline, while material handling/port solutions fell 15%, materials processing fell 11%, and cranes fell 9%. Aerial work platforms were the only exception, as this business grew by 5% this quarter.

Caterpillar’s results weren’t impressive either. The company reported its fourth-quarter profit fell 55%, mainly due to a $580 million write-down for an acquisition in China.

The Verdict

Joy has an average ROE of 41.7% over the past 5 years -- a spectacular return to shareholders. On both earnings and enterprise bases, Joy's stock is still significantly undervalued relative to peers. This company may have a rally in its future.

Anindya7 has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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