Not all investment decisions go right, even if they are made in companies that belong to sectors no economy can do without. One great example is the mining equipment industry. Without those shovels and excavators, miners will not be able to unearth rich natural resources vital for the economy.
Yet, mining equipment leaders like Caterpillar (NYSE:CAT) and Joy Global (NYSE:JOY) have had a tough time lately as a global slowdown forced miners to push back investments, thereby hurting their top and bottom lines significantly. The persistent weakness in stocks of both companies reflects those fears.
Of the two, Joy Global investors have been hit harder, with the stock losing 5% over the past three months, and a dismal 21% year to date, as of this writing. With the company set to report its third-quarter numbers Wednesday, can investors expect a breather?
Why revenue won't matter
Joy Global surprised the Street in each of its last three quarters. If the company does it again Wednesday, it will be welcome news. Analysts have low expectations, projecting Joy to post a sharp 25% drop on earnings per share on a 15% decline in revenue.
While a decline in revenue is never good news, what investors should really look for in Joy's upcoming earnings release is any increase in new orders and backlog. Because Joy records revenue only when it delivers prior orders, growth on the top line doesn't really mean Joy's business is doing well, nor does it say anything about where Joy's business is headed. On the other hand, an increasing backlog means higher potential revenue in the future, which is what investors really want to see.
Unfortunately, Joy's third quarter may disappoint. Backlog in Joy's previous quarter slipped 8% sequentially, while new bookings declined 8% year over year. The downward trend is likely to continue into the third quarter, since Joy's order flow directly depends on how much mining companies want to spend. As of now, most miners are sitting tight on their wallets.
For instance, Rio Tinto's (NYSE:RIO) capital spending on exploration and evaluation declined $483 million year over year during the first half of the year. Furthermore, Rio aims to cut its full-year capex spending by 20% from its 2012 level. That's exactly the same percentage that mining company Peabody Energy (NYSE:BTU) will lower its capital spending by this year.
Watch out for...
On a brighter note, Peabody foresees an improving coal market in the U.S. for the second half as inventory levels ease. Joy also booked one project that was pending for almost a year in its previous quarter, signaling that mining projects might have finally started moving.
Better yet, Peabody continues to remain bullish on key global markets like China and India, expecting coal imports from these markets to rise 15% this year to hit a new high. That's an excellent piece of news for Joy, because markets outside the U.S. make up a major portion of its revenue. So if sales from international markets in Joy's third quarter improve sequentially, that could indicate better days ahead.
The critical point
But of all the numbers in Joy's upcoming earnings release, the company's outlook for the full year, and beyond will take center stage. The markets are particularly cautious after Caterpillar recently downgraded its revenue and net profit guidance substantially on the back of lower demand for mining equipment. Sales from Caterpillar's resource industries division, which largely caters to the mining industry, plunged 34% year on year in its last quarter.
Joy had already lowered the projected higher end of its full-year revenue guidance by 4% in its previous quarter. Any further downward revision could see Joy's stock falling to new lows.
In its upcoming earnings call, Joy investors should pay close attention to what the company is doing to trim costs and strengthen its balance sheet. Efforts to maintain margins and improve cash flows during these difficult times could go a long way in helping Joy exploit opportunities better once the business environment improves.
Things may already be turning around, since rating agency Moody's recently improved its outlook for the coal industry, and as I write this, the latest manufacturing numbers from China have reportedly turned in much better than expected. So Joy's earnings release is actually coming up at a crucial time, because if the report reflects any of the optimism, it could also mark the beginning of a new rally for Joy Global shares.