Are Joy Global's Results Really as Good as the Market Thinks?

Joy Global's results impressed the market, but should investors be more skeptical?

Jun 16, 2014 at 8:33AM

Joy Global (NYSE:JOY) has been an underperformer during the past year or so, and many investors had given up on the company. During the last two years, Joy's shares have traded in a tight range. Meanwhile, the company's fundamentals have only deteriorated. However, the company's recently released fiscal second quarter earnings have buoyed investor confidence in the company.

Are these results as good as the market has made them out to be? Is Joy recovering, or is the company still in trouble? 

Digging through the numbers
Initially, the market reacted well to Joy's earnings. The company reported headline adjusted EPS of $0.76, down from $1.73 a year ago but up from $0.48 reported during the first quarter. The consensus estimate was for EPS of $0.71. What's more, management guided for full-year earnings of $3.10 to $3.50 per share; the Street is expecting full year EPS of $3.25. 

On the face of things, these results look ok. Dig a little deeper, though, and problems start to crop up.

Even if Joy hits its high-end full-year EPS targets, the company is trading at a forward earnings multiple of just under 19. This leaves no room for disappointment.

Other factors such as slumping sales (down 32%) and declining bookings (down 7%) were to be expected, taking into account the strong comparable figures reported last year. Furthermore, the company's operating margin collapsed from 20% reported during the same period last year to 13% during this period. Shareholder equity also fell. 

Dismal outlook
Aside from the headline figures, one of the most concerning things about Joy's quarterly release was the company's outlook. Joy's outlook on the global mining industry is dismal. Key points are:

  • Seaborne thermal coal markets remain challenged as supply is outpacing demand growth.
  • Chinese coal market conditions remained challenged during the first calendar quarter of 2014 as a depressed pricing environment weighed on many large producers. There appears to be limited upside for pricing improvement as seaborne coal prices continue to pressure domestic Chinese producers.
  • Notwithstanding the global steel production increase in the first quarter, iron ore prices have also declined and averaged $111 per ton over the last two months, largely owed to supply increases hitting the market.
  • After seeing an estimated market deficit of 270,000 tons in 2013, the global refined copper market is expected to move into surplus for the first time in four years.

It seems as if all of Joy's key target markets are heading into oversupply. However, one area where the company did display optimism was in oil sands:

"One area we are seeing growth is in the oil sands market. We received a large order this quarter for several electric mining shovels which will add to our fleet currently working in the Canadian oil sands region..."

It is unlikely that oil sands will singlehandedly be responsible for Joy's recovery, though.

Will the pain continue?
Unfortunately, other mining industry trends also suggest that Joy is going to struggle going forward. In December of last year, Rio Tinto (NYSE:RIO), one of the largest mining companies in the world, announced that it was going to slash capital spending. 

The world's second-largest mining company will cut capital spending to about $8 billion in 2015, to less than half of its outlay for 2013. This move follows a similar move by Vale, which slashed its investment budget for a third straight year to $14.8 billion -- the lowest since 2010.

Alongside the revelation that it was going to slash capex, Rio's chief executive Sam Walsh revealed that "Our capex is reducing, and will come down further...From where I stand, we continue to see market fragility and volatility."

It would seem as if things are only going to get worse for Joy.

Part of the reason that Rio is cutting capital spend is to pay down debt and increase shareholder returns. This is something that the industry has been trying to focus on recently. 

Foolish summary
All in all, it would appear that while the market responded well to Joy's fiscal second quarter announcement, it might have overreacted. 

There are plenty of headwinds going forward that could impact the company's performance. On top of that, the coal market is not yet showing any sign of recovery. Joy's valuation looks expensive, even based on high-end estimates.

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