Can These Divergent Mining Trends Coexist?

Equipment makers like repeat service business, but miners like Cloud Peak are saving big money doing the work themselves.

Jun 24, 2014 at 11:48AM

Mining equipment maker Joy Global (NYSE:JOY) believes a service uptick is a silver lining on a dark industry cloud. However, Cloud Peak Energy (NYSE:CLD) is saving big money by bringing services in-house as miners around the world look to trim costs. Is Joy Global's silver lining going to turn out to be a bit tarnished?

Good news at Joy Global!
In the company's fiscal first quarter (year ended in October), Joy Global CEO Edward Doheny noted:

While commodity prices remain range-bound, the ability to delay rebuilds and service in most regions appears to be nearing a conclusion. Our service bookings in the first quarter increased year-over-year by 4%, the first year-over-year increase since the third quarter of 2012.

This segment sells parts and services for Joy Global products.

The news was even better in the fiscal second quarter, when Doheny was able to report that, "service orders of $697 million were up 8%. This is our second consecutive quarter of year-over-year growth in service bookings."

(Source: Joy Global, via Wikimedia Commons)

This trend is important on two fronts. First, as Joy Global's Doheny suggested, companies can only hold off on repairs for so long. The same is true for buying new equipment. You can only repair the old machines for so long before it doesn't make sense anymore. So this is a trend you should be watching.

However, the increase in service spending is also showing that miners are increasingly frugal. And on that front, Cloud Peak Energy provides some compelling reasons to believe that Joy Global may have to wait longer than it expects for a notable businesses upturn.

Working in the garage
At a recent conference, Cloud Peak Energy talked about its efforts to reduce costs by buying used and doing more work in house. And the numbers add up. For example, buying a used "dozer" cost Cloud Peak Energy $250,000, nearly 85% less than buying new. The miner had to spend $400,000 to fix the equipment, however, bringing the grand total to $650,000 -- still roughly 60% below the cost of buying new.

You can see why Joy Global's service business might be picking up and why new sales could remain sluggish for a much longer time. However, Cloud Peak Energy is also doing more work in-house. On that front, the company's decision to do its own wheel repairs is telling. An outside quote came in at $320,000. Doing the work itself saved Cloud Peak Energy $200,000 on that quote, or roughly 63%.

(Source: T.Voekler, via Wikimedia Commons)

In fact, savings from doing things in-house led Cloud Peak to open a rebuild shop at one of its mines. That facility will help Cloud Peak to keep its costs down, and it won't be shut down if the coal market starts to pick up again. That means that equipment makers like Joy Global have potentially lost Cloud Peak as a service customer for the long term.

How big is this issue?
As the frugal trend continues across the mining industry, it's important to ask just how big an issue this will be for equipment makers like Joy Global. Mining equipment is heavily used and wears out fairly quickly. Services and parts provide a solid recurring revenue stream in an otherwise lumpy business. Joy's service-bookings uptick says that this side of the business isn't going away even if customers are getting cheaper.

That's good news because the service business represented about 70% of Joy Global's sales in the fiscal second quarter. Obviously that number is much lower when equipment sales are trending higher, but service revenue is what's holding Joy Global's business up right now. If new product sales don't pick up, Cloud Peak-like frugality could mean that meager growth on the service side makes the outlook for Joy Global weaker than the company now expects.

It's hard to tell at this point if a service-led slowdown at Joy Global is in the cards or not. But you should watch this segment of the business closely. And keep an eye on equipment customers like Cloud Peak as a leading indicator.

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Reuben Brewer 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.

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