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What Joy Global Didn't Say

By Lee Samaha - Mar 11, 2014 at 9:15AM

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Joy Global and Caterpillar are facing uncertain end markets in 2014, and Joy Global's recent results provided as many questions as answers.

Mining equipment company Joy Global ( JOY ) gave results recently, but the real news wasn't so much about what the company said, it was about what the company didn't say. The earnings report was positively received by the market, and investors in competitors like Caterpillar ( CAT -0.15% ) took heart from some of Joy Global's commentary. On the other hand, most of the good news was stock specific, and the underlying end-demand drivers for mining machinery still look weak in 2014. So what exactly can Fools learn from the results?

What Joy Global said in its first-quarter results
The company raised the mid-point of guidance by issuing adjusted diluted EPS guidance of $3.10-$3.50 versus previous guidance of $3.00-$3.50. The bottom end of earnings guidance was raised, and management expects that margins will further improve in 2014. Quoting from the recent Joy Global conference call: "We expect improvement in the company's operating margin driven by sequentially higher service sales and increased realization of savings from our cost-reduction programs."

Moreover, the cost-reduction plans of $75 million in savings for 2014 (net sales were $5 billion in 2013, with operating profit of $822 million) were declared to be "on track" with previous guidance.

Focusing on service revenue for the moment, there were a few positives to be taken away from the results and commentary:

  • Service orders increased 3.7% (up 11% in constant currency), representing 71% of orders in the quarter.
  • Investment continues in global service centers in order to support its installed base.
  • Management believes it has an opportunity to grow the consumables part of its service business from being a low-single-digit part of its business to being around 20% in the future.
  • Increased service revenue implies that conditions are beginning to bottom out.

In other words, while Joy Global original equipment orders were down a whopping 42.7% (making up 29% of orders in the quarter), Joy Global might be able to achieve some secular growth (through increased consumables sales and investing in service centers) in order to offset weakness in mining capital machinery sales.

A better economic outlook
Investing Fools already know about what will govern Caterpillar and Joy Global's  prospects in 2014, as well as the short-term risks facing them. While, Caterpillar's construction and power systems segments (both expected to grow 5% in 2014) can be expected to offset mining weakness, Joy Global is full exposed to the vagaries of the mining market.

In this regard, management cited economists' expectations for stronger global growth this year. North America is strengthening, while China's GDP growth is expected to come in at 7%-8%, and the eurozone is starting to grow again. The read is a good one for commodities, because the conventional wisdom is that good news for the economy equals good news for commodities.

What Joy Global didn't tell you
To be fair, its management was quite candid that soft market conditions were encouraging customers to defer capital investment. In addition, it gave a bearish forecast of $115 per ton for iron ore prices in 2014.

Iron Ore Spot Price (Any Origin) Chart

Iron Ore Spot Price (Any Origin) data by YCharts

However, what Joy Global's management didn't say (nor could they have been expected to say) can be expressed in the following three arguments.

First, not all cycles are the same. Just because the global economy is getting better, it doesn't necessarily mean that commodity prices will increase in step. In fact, China is making a conscious effort to replace coal-powered energy plants in favor of natural gas plants, and it's no secret that the U.S. is planning to retire significant amounts coal-fueled, generating capacity over the next decade.

Second, financial conditions have gotten tougher in many emerging markets;,making it even harder for many coal producers to keep their heads above water. Indeed, China has already seen a default on a trust backed by a coal company. Moreover, there are fears in the market that a public corporate bond default could be due soon. It's hardly a positive environment for emerging market coal producers.

Third, despite the optimism over Joy Global's service sales, Fools need to remember that the biggest driver of forward service sales is usually a combination of current original equipment sales (weak) and the outlook for commodity prices (questionable). In other words, don't expect that service sales can strengthen notably if original equipment sales keep weakening.

The bottom line
The fact remains that this is still a weak environment for Joy Global and Caterpillar's mining machinery sales. The key questions about their end market demand remain unresolved, and actually appear to be getting worse. The cold weather was a net positive for coal demand, but it won't last forever.

On a more positive note, Joy Global is taking measures to cut costs and wring growth out of its service sales, so if you believe that coal is going to make a comeback in 2014, buying the stock just got that little bit easier.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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