There's not much Joy Global (JOY) investors can look forward to, for at least another year. That's what the company's latest earnings release had to say. Plummeting orders, depleting backlog, dour guidance -- Joy's report had everything to scare an investor away.
But the market seems to have missed something. Joy's order book is actually showing signs of fatigue that were last seen during the crisis of 2009. I am not saying so -- the company is. Now, if that doesn't sound like a warning bell, what does?
Where Joy is losing ground
The fact that Joy gets more than 60%
of its sales from coal-mining customers seals its fate for another year or so. Coal producers like Arch Coal (NYSE: ACI) and Peabody Energy (BTU) may have reignited hopes with their recent surprise profits, but that doesn't help Joy's case. Both companies have ardently cut costs in recent quarters to maintain margins, which is hardly the piece of news that a mining-equipment maker like Joy would want to hear.
Arch Coal has already reduced its capital expenditures by a whopping 45% since 2011, and is planning further reductions for 2014. Peabody is cutting its capital expenditures by 50% this year while deferring projects in the longer run.
2009 is back to haunt
As coal producers tighten their purses, demand for Joy's equipment could only fall further. New orders in Joy's third quarter plunged 36% year over year. Worse yet, bookings plummeted 38% sequentially, indicating that the situation in Joy's end markets is only worsening.
Now here's the scary bit: Joy didn't book any orders for its shovels or longwall mining equipment in the last quarter. The last time that happened was in 2009. Though Joy called it "an unusual situation" and expects orders to pick up soon, the fact that the mining malaise has deepened enough to bring back frantic memories of the 2009 crisis suggests that the recovery could be painfully slow.
Subsequently, Joy expects to end its financial year 2013 with roughly 13% lower revenue. The outlook is even bleaker for 2014: Falling orders may restrict Joy's annual revenue to around $4 billion, which would be a 20% fall from Joy's projected 2013 revenue.
It's not a one-day story
The real concern is that the headwinds may not be restricted to a year or two. Even as coal prices hit multiyear lows, Australian miners have ramped up production in recent months in the wake of a lower Australian dollar. For instance, Peabody, which derives more than 40%
of its revenue from Australia, reported a 5% increase in last quarter' coal volumes from its Australian operations even as prices dropped 5% year over year.
Australia has thus put further downward pressure on coal prices while adding to the supply glut. Meanwhile, the nation's primary trading partner, China, continues to import greater amounts of coal even as its high-cost domestic stockpiles remain high. In 2012, despite the Chinese economy slowing down, the country's coal output increased 4%.
The climax could stink
China will have to wind down its existing inventory to see new production go online. Meanwhile, its coal industry is likely to enter a consolidation phase, which could see thousands of smaller mines go out of business. Furthermore, China has an ambitious target to reduce coal consumption by nearly 45% by 2020 amid environmental concerns.
None of these factors bode well for equipment makers like Joy and Caterpillar (CAT 0.59%), both of which acquired a China-based mining-equipment company each last year. If a paradigm shift toward cleaner fuels shrinks China's coal market in the years to come, Joy could be hit hard because nearly 18% of its revenue comes from the market. Caterpillar currently gets just 3% revenue from China, but most of its growth plans revolve around the market.
Closer home, things look equally murky. Arch expects 35% of the coal units in the U.S. to shut down in the next five years. While that may sound like a bold projection, Arch's forecasts can't be taken too lightly since it controls nearly 15% of the total coal supply in America.
Simply put, there's too much uncertainty regarding Joy's primary markets, which bodes ill for the company and its investors.
So what should you do?
All's not lost for Joy investors, though, because the company is prudently doing what it should in these challenging times: restructuring operations to trim costs. After saving $47 million in costs this fiscal year, Joy plans to shave off another $75 million from costs in 2014.
More importantly, Joy's inventory level is easing, which is also why the company expects to generate about $500 million of cash from operations for the full year, as compared to $443 million in 2012. Adjusting for its projected capex of $150 million, Joy should have nearly $350 million as free cash by October when it ends its financial year. That's a good jump from last year's $200 million worth of free cash flow. A part of it will go into shareholders' pockets in the form of buybacks. Greater dividends would be better any day, but buybacks also reflect management's confidence in the business.
That said, savings wouldn't help until the top line grows. It could be too early to say that Joy's stock has bottomed, given the company's thinning order book and unfavorable market conditions. The stock is at its weakest, and any negative news out of China could send it lower.
While coal might quickly bounce back in the game, especially if natural gas prices strengthen, its future looks dark to me. Instead, I'd prefer going for a company like Caterpillar, which doesn't depend on mining alone. With the end markets looking murkier, Joy stock's bearish trend, which began in 2011, could last longer than warranted.