Mining, Farming and Construction Profits: Heavy Machinery

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When an economy struggles to grow steadily, investments focused on capital become scarce. Mining, farming and construction are three industries that require heavy capital investment and have suffered greatly through the recession. Fortunately, with new economic winds in the USA, companies like Joy Global (NYSE: JOY), Komatsu (NASDAQOTH: KMTUY), and AGCO (NYSE: AGCO) have begun to show improvement.

Asian innovation

The world’s second largest construction company, Komatsu, based in Tokyo, Japan, manufactures and markets construction, mining and military heavy machinery. Its products are sold mainly in Japan, the USA, Brazil, the UK and Germany. Recently, the firm has seen a price drop due to the slow performance of the Tokyo Stock Exchange.

In the short run, Komatsu will continue to increase its presence in the Asian market, especially in China. This strategy is compatible with curbing Caterpillar’s strength in North America and Europe, and an attempt to absorb as much growth as possible from the Asian region. In the long run, the introduction of hybrid-powered engines and GPS tracking services, as well as continually improving internal efficiency and inventory reduction, will fuel future growth and secure profits.

The slow performance of the Asian market affected Komatsu’s balance sheet. The development of new technologies took a toll on cash flow, and a slow regional economy reduced revenues. Nonetheless, the firm has developed and introduced new technologies that will drive costs down. Such benefits are in line with market preferences around gas conservation and precision improvements.

Currently trading at 18.2 times its earnings, meaning a 68% premium to the industry average, paying $0.2195 quarterly dividends, the stock is overvalued. It is recommended to hold because new products address market tendencies not identified by competitors. Fuel consumption and GPS technologies will quickly be accepted by customers, because these are the new market preferences not identified or exploited by industry peers.

American standard

Based in Duluth, Georgia, AGCO manufactures and distributes a wide range of heavy machinery for farming in over 140 countries. Tillage equipment, forage, hay tools, tractors and combines are the most widespread products. Lately, the firm made the news when it introduced new global precision farming equipment. This is not minor, as GPS utilities are becoming more common in the farming industry.

AGCO is focusing its future strategy around making profits by improving internal efficiency rather than expanding operations to new markets. That is, management will continue policies started in 2006: improve the performance of recent acquisitions, and shed off non-performing segments. Additionally, the company entered the most relevant emerging markets and has built a strong presence in the EU. In the future, the firm will continue to wrestle with giants like Deere and CNH in the North American market, while continuing to increase operations in China and India. Nonetheless, key strategic acquisitions may very well continue, although at a slower pace in order to ease the integration process and reduce inefficiencies.

Financially, AGCO is very strong. Revenues have increased steadily during the last three years. Debt has also risen in relation to the acquisitions completed during 2012. However, this is not alarming since the model continues to improve performance, as evidenced by higher operating margins. Last, the overall performance allowed for a moderate buyback policy, raising the value of shareholders' positions.

Trading at 10.6 times its earnings, standing at the industry average, and paying a $0.10 quarterly dividend, the stock is fairly priced. It is recommended to hold because returns are small, and the company continues to face great competition, even with a small economic moat.

Decaying American

Based in Milwaukee, Wisconsin, Joy manufactures, services and distributes heavy machinery for surface and underground mining. Operations are divided between four segments: P&H Mining Equipment, Joy Mining Machinery, Continental Crushing and Conveying, and Services. Most recently, the company caught analysts' attention as full year guidance was lowered.

At the moment, Joy is experiencing slow performance due to the commodity cycle, aggravated by a concentrated pool of customers, a need to update its products and scarce new mining projects. Ahead, value added aftermarket services, adjusted operative costs and a rising industrial demand from the USA, China, and India will offset the slowdown. Hence, the firm has to take several steps in order to secure future growth, or it will continue to lag behind the competition. So far, no signs of a new strategy have been hinted by management, and performance remains dependent on economic recovery.

The balance sheet presented by Joy is in decay. Revenues have risen during the last three years, but cash flow has been greatly reduced and debt has soared to unseen levels, putting a check on the business model. On the other hand, operating margins stood at 20% through the last three years, and cash has been used to benefit shareholders. Although this last point is very good, future profits are not secure and the time for opting out seems to have arrived.

Currently trading 7.4 times its earnings, packing a 31% discount to the industry average and paying $0.175 quarterly dividends, the stock is undervalued. It is recommended to hold until management takes a decisive step to reduce debt, fully integrate recent acquisitions or presents a clear and profitable strategy for the long term.

Collecting thoughts

I prefer companies with high yield and double digits operating margins. Komatsu fulfills those two minimum requirements. In addition, the firm is the industry’s latest innovator with the introduction of hybrid engines. Such products have granted an edge over the competition, and customers have recognized the benefits from it. I expect the firm to perform very well in the future as gas prices continue to rise and alternative energies become standard.

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