With a Great Management Team on Your Side, Time Is Your Friend

Why Joy Global is an excellent investment opportunity for patient investors

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Oct 07, 2015
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Joy Global (JOY, Financial) manufactures mining equipment both for use in open pit and underground mines. The stock has been punished with the commodity sector in the gutter due to the slowdown in the Chinese economy and Joy Global’s heavy reliance on sales to the coal industry. Coal is especially out of favor as politicians increasingly favor other energy sources because they are less polluting.

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Financial state

If there is something not to like about Joy Global, it is the level of its debt. With $1.25 billion of debt against a $1.57 billion market cap the size of it, is significant. The good news is that a major part of its total debt is only due beyond 2019. That gives the company a lot of time to weather the current storm in the commodity industry.

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Management

Joy has quite a formidable team of executives who know how to get results. The past three years RoIC and RoE have not been great but before that, the returns have been stellar. However, these returns are heavily influenced by the state of the commodity markets. The current CEO Edward Doheny has previously served as VP of the corporation and president and COO of the Underground Mining Machinery business, from 2006 to 2013. His predecessor is the current chairman who ran several different industrial and capital goods businesses before signing up with Joy Technologies. At Joy he also served as president of the Underground Mining Machinery Division. Under his leadership the company enjoyed a decade of great success. Competitor Caterpillar (CAT, Financial) operates with the disadvantage of having to manage a larger asset base, but it also enjoys a stronger competitive advantage through its larger scale. Yet Joy managed to outperform it in ROIC over the past 10 years quite clearly:

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Chart: ROIC for JOY, Komatsu (KMTUY, Financial) and CAT

Overall, I think the quality of leadership should be deemed high and viewed as a favorable component of investment.

Risks

The major risk Joy is facing is a prolonged spell of underinvestment in the commodity space. When commodity prices are low, miners do not invest in new equipment. This has a profound affect on Joy’s sales of machinery and subsequently service contracts. Joy also has lots of exposure to coal miners just now; both China and the U.S. have expressed a strong desire to reduce CO2 emissions through reducing coal burning. When sales fall to extreme lows, the company may also come under pressure regarding its debt load. Although in the vast majority of possible future scenarios it will be able to manage this, it can become a lethal drag.

Valuation

In my opinion it currently does not work very well to value Joy Global by comparing it to peers like Caterpillar. The reason this does not work very well is that the entire sector is strongly out of favor. By solely comparing Joy Global to industry peers it is going to look like a marginal opportunity at best.

That is why I employed a DCF calculation instead to arrive at a net present value estimate of the stock’s value. Be aware that DCF models are notorious for being able to generate a wide range of outcomes depending on the assumptions you deem realistic.

The assumptions I have made are that Joy Global will be able to grow its EPS quite strongly over the next seven years as the commodity markets slowly claw their way back up. Due to the management team, which is looking good and the firm’s competitive advantage as a trusted supplier of mining equipment and service at a good price, I have put the growth rate relatively high. I use a terminal growth rate of 0% and discounted against the Standard & Poor's 500’s average 11%.

That leads me to believe the net present value of a share of Joy Global could be as high as $61.14, implying a possible upside of 281%. The market obviously does not agree with me on the value of Joy Global. GuruFocus offers a DCF tool with which you can play around and input assumptions you think are reasonable. I highly recommend running it a couple of times to see how different assumptions change the outcome of the net present value.

Outlook

You can get lucky, of course, but it is reasonable to expect business being fairly slow in the near term at Joy Global. The company is engaging in cost-saving initiatives that should help mitigate the China effect in part but only in part. However, if we look beyond the first year or so and focus on the long-term perspective of the company, things are looking up. There is a solid team in place. Ironically the company may benefit from the slowdown in the Chinese economy as the pressure may be too much for several competitors.

If these businesses go bankrupt, that opens up the market for Joy Global while the company itself is not in immediate danger, which in turn will enable the company to sustain higher margins for a period of time before new entrants start frustrating its efforts once again.

Business remains an endless battle in commoditized industries. With a great managment team on your side, time is your friend. Every quarter provides them with opportunities to show off their skill and best the competition. Slowly it starts adding up, and that is how great track records are made.