Digging for dollars
Mining-equipment maker Joy Global has thrived during the commodities boom. How will it fare in a slowdown?
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| An underground coal mining entry driver from Joy Mining Machinery. |
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| A view of truck loading operations from inside the operators cab of a P&H power shovel at work on the Minnesota Iron Range. |
(Fortune Magazine) -- Making shovels and drills to dig up coal, copper, and other commodities may not sound particularly sexy. But lately it's been among the best business opportunities around.
For proof, look at Joy Global (JOYG), one of the world's leading manufacturers and marketers of mining machinery and equipment. Thanks to robust foreign demand for mining goods, particularly in emerging markets, Joy's stock has soared fivefold in the past five years, beating the 42% return of the S&P 500 by a wide margin. Such explosive growth helped earn the company a spot on the 2007 edition of Fortune's Fastest-Growing Companies list.
In the months since our list came out, Joy has continued to live up to its name for shareholders. Orders for the Milwaukee-based company's mining equipment were at record levels in last year's fourth quarter, totaling $968 million, a rise of 16%. The orders have filled the company's capacity for 2008 and almost all of 2009, said CEO Mike Sutherlin during a recent conference call with investors. For the full year Joy earned $473 million on sales of $2.6 billion in fiscal 2007, leading to a 37% jump in the stock price last year, trouncing the 5% gain of the S&P 500.
Can that remarkable performance continue in 2008?
Demand for mining equipment is driven by commodity prices, and despite the slowing global economy, many commodities are still trading well above their historical averages. But bearish Morningstar analyst Joel Bloomer warns that Joy's stock could tumble if coal, copper, and iron ore prices fall to their historical averages. Though Bloomer doesn't forecast specific commodity prices, he points out that the predecessor to Joy Global, Harnischfeger, went bankrupt in 1999 because it was unable to survive the harsh bottom of the cycle.
"It's an extremely volatile business," says Bloomer, who believes that the stock is some 80% overvalued. "It's not being priced as if it were cyclical, which doesn't make sense."
Bulls such as Value Line analyst David Reimer, however, contend that while there may be bumps along the way - such as now - robust overseas markets will keep the mining sector booming. Reimer points out that the industrialization of China, India, and other emerging nations is straining the world's ability to extract commodities fast enough to meet demand. "Notwithstanding recent macroeconomic difficulties, the current mining upcycle might well extend into the next decade," he notes.
CEO Sutherlin agrees. "The mining industry's production capacity has fallen behind the growth in commodity demand, and this has resulted in supply shortages and dramatic increases in commodity prices," he says. "The price increases underlie the expectation that it will take several years and significant investment for capacity to catch up to demand."
To increase capacity, Sutherlin is building new factories in areas with low production costs that are close to customers. Among other things, he will spend $70 million to build Joy's third factory in China. By 2012, Sutherlin aims to place 35% of its worldwide capacity in similar low-cost factories. Overall, Sutherlin couldn't be more upbeat about the company's prospects. "The outlook for our markets is stronger than ever," he says. "Supply continues to chase demand in our international markets, including coal, copper, iron ore, and the Canadian oil sands."
Although Joy is certainly not immune to commodity price swings, Value Line's Reimer points out that the company's aftermarket parts and services division, which accounts for 65% of sales, should help stabilize performance if demand for original equipment stalls. This division provides a reasonably reliable stream of revenue.
As with Joy's future prospects, the polarized views regarding the company are reflected in its stock. The consensus forecast among Wall Street analysts is for Joy's per-share earnings to jump a staggering 47% annually for the next five years. (Morningstar's Bloomer doesn't forecast earnings growth and therefore isn't included in the consensus.) Yet with the stock selling at 19 times projected earnings - slightly below its historical average - the stock's price-earnings-to-growth, or PEG, ratio is a remarkably low 0.40. (Stocks are generally considered cheap when their PEG ratios are below one.) Either analysts' growth expectations are way too high, or investors are drastically underestimating Joy's prospects.
David Jordan, for one, has a slightly more nuanced take. Jordan, the lead manager of the First Focus Growth Opportunities fund, has delivered a market-beating 15% annualized return for shareholders in the past five years and holds about 2% of his fund's assets in the stock. He believes that analysts' forecasts are too high, but that Joy's prospects are bright nevertheless. He figures the company can grow in the mid- to high-teens for the foreseeable future. Says Jordan: "Even at that level, the PEG ratio looks attractive to us." 
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