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Low Mineral Prices Hide a Winning Option
Posted by: Vanina Egea (IP Logged)
Date: September 3, 2013 10:37AM
After hitting a historical high in 2011, prices for mining products entered a downtrend that continues throughout 2013, further pressuring margins and reducing demand for new equipment. Hence, prospects for Caterpillar (CAT), Komatsu (OTC: KMTUY) and Joy Global (JOY) have suffered. But, have managements taken the cue? And, how have hedge funds reacted?
The Bigger They Are, the Harder They Fall
Caterpillar is the largest company in the mining equipment sector, and suffered a 16% year-over-year revenue drop in the last quarter. Hence, if the current downtrend continues the company is expected to face additional difficulties.
The first indicator for a troubled future is Caterpillar’s reduced sales outlook range ($56 billion to 58 billion). Additionally, earnings per share are expected to be $0.50 lower at the end of the year, compounded by dealer’s inventory and backlog reduction for the long term.
Also, international exposure has offset improvements in the U.S. market. In short, the European market continues to wrestle with a slow recovery, while the Chinese and Latin American economies are expected to grow at a more moderate pace when in comparison with the last decade. At last, the competition abroad continues to strengthen and is expected to eat away market share.
Financially, Caterpillar is sound. However, it did not stop Jim Simmons and Tom Russo from selling out, and Steven Cohen from reducing their position by more than 50%. I remain bearish about the company because global sales are not expected to see much growth, the Brazilian market is suffering from a depreciating realand cost reduction will not be enough to offset market trends.
Currency Benefits vs. Slower Sales
Komatsu is the second largest construction and mining equipment manufacturer with a market cap less than half that of Caterpillar. Concerning performance, management affirmed, “While demand for mining equipment should decline, demand for construction equipment should advance in Japan and North America. Coupled with expanding sales of parts, the Japanese yen’s depreciation and other factors, both sales and segment profit for fiscal year 2013 should increase from fiscal year 2012.” Additionally, management aims to raise its dividend yield by five yen.
However, declining sales volumes and profits compromise Komatsu’s prospects. While the Japanese market does not offer much room to grow, the U.S. market is strongly dominated by Caterpillar. Additionally, the Chinese economy is expected to grow at a slower pace, and new domestic competitors continue to eat away market share.
On the other hand, the company’s innovation granted the firm a technological advantage over the competition. However, hybrid engines and GPS tracking devices have not generated enough growth to offset lagging sales. At last, the strategy focused on recovering margins to boost profitability is expected to be exhausted at the end of the cycle.
The balance sheet for Komatsu also raises concerns over future performance. Most importantly, Ken Fisher, the only guru investing in the firm, sold out during the first quarter. I remain bearish about the stock because management has yet to take a strong decision with respect to slower market activity.
Enjoying Low Prices
Joy Global is the smallest among the three most important mining equipment manufacturers with a quarter of Komatsu’s market cap. With stock price touching bottom at the end of last year, the company offers a good discount. Unlike Komatsu and Caterpillar, Joy Global is solely dedicated to mining equipment, and revenue is equally generated by original equipment sales and aftermarket services.
The strategy developed by Joy Global to secure future profits is based on cost structure optimization, alignment of production capacity with demand, improvement of manufacturing efficiency and production relocation to politically stable and low-cost countries. Also, acquisitions have incremented international exposure and widened product offering.
Those decisions have lifted the firm’s competitiveness in the Asian market, expanded market share, and countered Caterpillar’s recent acquisitions. At last, the company is more isolated from cycles through long-term contracts for service work, which provides almost 50% of revenues.
Financially, Joy Global is the strongest in the industry. Jim Simmons, Joel Greenblatt, Steve Cohen, and Paul Tudor Jones are some renowned investment gurus that took new positions during the current year. I feel quite bullish about this stock, mainly because management developed a new strategy to counter market trends and continue growing.
Lower commodity prices have hurt most miners across the board, and before cutting dividend payout, supplies were adjusted. However, Joy Global responded in kind and fine-tuned its business model to cope with current market trends. Hence, I recommend Joy Global over the other two, because it developed a business model focused on current adversity and future growth.
Guru Discussed: Joel Greenblatt: Current Portfolio, Stock Picks
Ken Fisher: Current Portfolio, Stock Picks
Stocks Discussed: CAT, KMTUY, JOY,