Mike M has prepared an interesting argument for Joy Global (JOY) a mining equipment manufacturer based in Wisconsin. My comments follow his analysis:
What is JOY?
JOY is a manufacturer and servicer of mining equipment for the extraction of coal and other minerals, and ores. Its equipment is used in mining coal, iron ore, copper, oil sands, gold, etc. all over the globe. Joy’s equipment is used in the underground and aboveground mining industries and in other industrial applications.
JOY is one of three companies that dominate the manufacturing and servicing of industrial heavy machinery for global mining operations. They make the huge earth-moving machines that are essential to mining for natural resources. It competes with the likes of Caterpillar (“CAT”) and Bucyrus (“BUCY”). Not only does JOY make a lot of money selling their equipment, they also reap future benefits from the servicing of the equipment. JOY estimates that about 60% of its revenues come from the servicing arm of the company. The more they sell, the more they end up servicing and the more profits they generate.
JOY appears to have at least two moats –a brand moat and a toll moat. Brand moat - Companies in the mining business know that JOY is the best of breed in the mining equipment sector. I think that the average person sees CAT has having more name recognition because CAT’s products are highly visable at building sites for commercial and residential properties. We don’t really see mining sites or the equipment being used there. If we did, we’d see JOY’s equipment (P&H Mining Equipment and Joy Mining Machinery). Additionally, with limited competition comes pricing power. I believe JOY has pricing power in its market. Next would be a Toll Moat - The mining equipment sector appears to have high barriers to entry.
Red Flags: JOY generates about 70% of its sales from the mining of coal. If companies slow down the pace at which they dig for coal, then JOY will be disproportionately affected. However, even with the increased EPA standards/regulations in the US, global coal demand will not be disappearing anytime soon since it is estimated that about 50% of the world’s electricity is currently generated by coal.
Let’s look at some members of the management team: Michael W. Sutherlin is the CEO. His salary is $890K (total comp = $5.6m) and he’s been with the company since 2003.
Michael S. Olsen is the VP and CFO. His salary is $395K (total comp = $2m) and he’s been with the company since 2003. (I always list the CFO because I think it’s important to know who is generating the company’s numbers, how long he has been around, etc.).
I did not find any negative stories on either Messrs. Sutherland or Olsen or other members of management.
Is management driving shareholder value? The only thing that gave me pause was that the long-term debt is at $3.5 billion when the cash from operating activities is only at $505 million. It will take 7 years of cash from current operating activities to pay off this amount of debt. That’s a long time. However, management has a good reason of the increased debt load (which, in 2010, was only $396 million). Specifically, they have been acquiring smaller companies. This can be good or bad – it’s only good if the bigger = better.
It appears that the main cause for the increased debt load is due to their acquisition of LeTourneau Technologies, Inc. (“LeTourneau”) on June 22, 2011. The cost was approximately $1B. LeTourneau is a company that operates in three businesses, mining equipment, steel products and drilling products. JOY also turned around and sold the drilling products business purchased from LeTourneau to Cameron for $375.0 million in cash. Additionally, on December 29, 2011, JOY acquired approximately 41.1% of the outstanding common stock of International Mining Machinery Holdings Ltd. (“IMM”), a Hong Kong listed designer and manufacturer of underground and coal mining equipment located in China. JOY now owns 69% of IMM, and on January 6, 2012, offered to purchase the remaining shares. These acquisitions will help to solidify JOY’s dominance in the mining equipment industry thereby enhancing its brand recognition and pricing power.
MARGIN OF SAFETY
JOY meets the requirement of having growth rates in excess of 10% for a 10-year period.
ROIC: 11.5% (10yr); 15.8% (5yr);
BVPS: 20.8% (10yr); 25.5% (5yr);
EPS: 75.3% (10 yr); 14.9% (5yr);
Sales: 15% (10yr); 13.7% (5yr);
Cash Flow: 57% (10 yr); 11.8% (5yr).
The analyst’s growth rates range from 14 - 22% with the average being 17.5%. The 10-yr PE values range from -26 to 36, with the historical 10yr average PE being 14.3%. The current PE is 13.
JOY currently trades for $77 (when Mike wrote this up). Using a future growth rate of 16 and a PE of 20 yields a sticker price of $122, so the MOS is $61. It’s not quite at a 50% MOS, but it’s worth keeping an eye on as the global financial concerns continue to hang over the markets. Recently, during the sharp decline in all stock prices in October 2011, JOY traded at $57. The stock also pays a dividend of 0.70 (dividend yield = 0.91%). JOY recently stated that they “expect demand to grow at a more moderate rate in 2012,” which should put this stock under more pressure and possibly result in us seeing a great entry point for the long-term investor.
I think Mike nailed the Meaning section. JOY is the big dawg in their business. He also nailed the risks. This company is going where coal goes. You can see that in the Toolbox Chart analysis of Moat:
When the numbers are not parallel there is some sort of challenge to the ability of the company to protect its margins or revenues. In this case, its a problem with margins during recessions (or attacks on coal). Book value per share is struggling as well. The key to great long-term investing is to have a high degree of predictability in the company we buy so we can predict its value in the future from our estimates of earnings. When we have numbers like this it makes the result less accurate. When its less accurate we want a larger margin of safety or we walk away.
Looking at the slope of these numbers gives a view to the future growth rate by picking the line that looks most representative of whole. In this case I think the revenue line looks most promising - about 16%. Mike used 17% so we're close on our best guess about growth. Here's the valuation tool using 16% and a 24 PE. Mike used 17% and 20. No argument. I'm giving it the upper end of the high PE range. He's being a bit more conservative, which I like. Here's the result:
The Toolbox finds a Sticker of $144 with a MOS of $72. [Mike found an MOS of $61] The price is $82 so the MOS is a little thin. However, the 8-year Payback Time is at $90 so we have a great Payback Time from earnings. However, the Tangible Book Value is only about $13 per share for an $82 company so we have to be aware that the value here is mostly coming from future earnings power. With a nice nearly 7% earnings yield, and a good Payback Time, this company is marginally on sale at this price IF I really understand the risks inherent in this business. I'm not entirely sure I do so I'll be holding off a bit here while I dig in.
Thanks for the good work, Mike.
Now go play.