A Mining Name to Buy Despite Weak Mining Environment

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

The recently held “Diversified Industrial Conference” brought with it different investing themes across the industrial sector. A whole day was dedicated to machinery players. Some focused on headwinds in Europe, while others cautioned on a strengthening dollar and its impact on their exports. Various point of views were heard from players of the same league. However, there was definitely a common theme found across the sector: a warning on the bleak future of the mining sector. Let’s have a look at how three companies covered this aspect in their presentations.

Caterpillar started off the complaint

It has been more than six months since Caterpillar (NYSE: CAT) predicted a weak mining market. Those who have been following the mining sector know that mining capex peaked recently and is now destined to fall. Since demand for mining equipment is a direct function of mining capex, sales from mining equipment are expected to fall as a consequence.

Much of the Q&A focused on mining. Dealer inventory reductions have been concentrated in mining, and the company believes that further declines in mining production would lead to sales declines (on a year-over-year basis) in the company’s mining business in 2014. As a result, the company has come out with a cost-cutting program. However, the management believes the single largest risk to its outlook is cost structure and execution of its cost-reduction strategies in the near-term. Sudden, significant shifts in demand would also prove a challenge.

However, the company shouldn’t be considered as a pure-play on the mining sector. Caterpillar has a strong construction business. There have certainly been headwinds from the commercial sector, but improvement in residential construction has led to incremental revenue for Caterpillar. Similarly, the company has a strong and well-diversified power systems business. Sales to the oil & gas, rail and marine industries have been strong.

Joy Global not so joyful

Joy Global's  (NYSE: JOY) presentation focused on the company’s outlook in the current environment of declining mining capex. Commodity markets are in supply surplus, which has exerted downward pressure on prices and volume. Moreover, new CEOs at mining companies are being very conservative and have reduced capex budgets for mining equipment by ~40% since 2011.

However, there is a positive point. Most of the reductions in spending took place in 2012 and have already been factored into incoming order rates. Joy’s prospect list for new projects has also come down by about 40%, but is stable, suggesting that customers will likely maintain the current rate of capex deployment in the near-term. Despite the continuing negative tone of headlines around mining capex, the CEO is confident that there won’t be another step-function down in equipment demand.

In the near-term, management is focused on taking out costs to drive performance even in a weak demand environment, while still maintaining leverage when demand recovers. The “One Joy Global” program has been targeted to streamline its business operations.

Given that the stock is down 25% since the start of the year, it seems most of the bad news has already been priced into the stock. The stock is trading at a forward multiple of only 9 times, which is way less than the industry's average of 14 times. Apart from the restructuring program, the fact that the company’s increasing aftermarket revenue also serves as a positive.

Terex has also suffered from weak mining environment

Terex’s (NYSE: TEX) material processing segment contains a small proportion of exposure to mining activity, and hence has suffered as a result of slow growth in this sector. However, apart from that, the company has also suffered from a weak Yen, which has largely helped its Japanese competitors like Hitachi and Komatsu. The company’s cranes business has been a sign of hope, but the company has not been rewarded in proportion to its efforts.

The positives were that Terex Chairman and CEO, Ron DeFeo, discussed the company’s businesses and how they were progressing in relation to management’s long-term goals of $10 billion in revenue with 10.0% operating margins by 2015. The Aerial Work Platform business is running ahead of plan ($2.9 billion in revenue with 15.0% margins by 2015), particularly in Europe. The company has gained market share in Latin America, and its China business has turned the corner and is becoming profitable, though it is still relatively small. The CEO believes that replacement demand will support sales for the next two years, even though rental companies are likely to maintain older fleets than in previous cycles.

Final word

Declining mining capex as a result of weak demand for commodities has led to a bleak future for machinery companies. Some, like Caterpillar, have been more affected, while others, like Terex, have been less affected by this trend depending upon their level of exposures. However, on an individual basis, Joy Global looks to be the best investment among the three given its cheap valuations and strong aftermarket sales. 

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Zain Abbas has no position in any stocks mentioned. The Motley Fool owns shares of Terex. 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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