Joy Global first came up on my radar in a stock screen for cheap companies with good returns on invested capital. I became interested again when reading through the reports of several well known value investment managers and some had taken a position in JOY. So I thought I would do a quick profile of the company and share my thoughts on it.

Share price: $52

P/E: 10.6

Return on Investment: 14% (TTM), 32% (10 year average)

The business

Joy is one of the largest global manufacturers and servicers of high productivity mining equipment. It sells both new equipment (40-50% of sales), and parts to repair and upgrade existing equipment. Coal and resource stocks haven’t been doing well lately, and naturally, neither has Joy. The new equipment segment has seen large falls in revenue, but the parts segment has been more stable. 60% of sales are outside the U.S.

The company reports in underground and overground mining equipment segments. The chart below shows the split in sales, which is fairly even.

The resource sector as a whole is very dependent on commodity prices and, as a manufacturer of equipment used in mining, Joy is very reliant on the capital expenditure of mining companies. Joy in particular is heavily dependent on the coal, copper and iron industries.These industry’s capital expenditure has been declining rapidly over the last few years due to a slowdown in growth in emerging markets, and the commodity bull run seemingly coming to an end as supply has finally caught up with demand. Capital expenditure in the industry is expected to fall another 20% in 2014.

Joy’s latest conference calls have painted a bleak picture. Bookings were down 20-35% on the previous year, meaning companies are ordering less new machines. Net sales were down 26% to $1.2bn in the latest quarter and given the poor orders, sales are expected to fall to $4bn a year, compared to a peak of $5.7bn in 2012. EBITDA margins recently have also been at all time highs at 22.5%, compared to a 10 year average of 18.1%. In the last quarter this fell to the region of 16% excluding unusual items. So I think net profit on $4bn of revenues could come in between $400m and $500m in future. Compare that to the current Enterprise Value of $6.5bn and the stock doesn’t look so cheap, especially if this is a long term cyclical shift in the commodity markets.

The companies latest annual report gives more description of the risk factors it faces in the industry. I don’t have a specific outlook on commodity prices but here are the price histories of Joy’s important commodities

The prices appear to have stabilised somewhat, and Joy themselves have cautiously said it doesn’t expect the dramatic falls in its revenue to continue and is now at more of a ‘base’ business level.

But there are some positives on the financial side. Sustaining CapEx is said to be around $125m a year, roughly similar to depreciation so profits should all come through as free cash flow. It will also soon stop topping up its pension fund, freeing up another $100m in free cash per year. Management has shown to be competent capital allocators with a 14% ROI even in a depressed market. They have even managed to reduce inventory and trade receivable days despite the poor market conditions. Also any improvement in the mining industry would benefit Joy.

Historically all free cash has been spent on acquisitions, with dividends and share buybacks being funded through issuance of debt which I am less enthused about.

Conclusion

At the current price there are too many risks for me to take a position. Although it appears a well run business, it doesn’t strike me as undervalued unless an upturn in the commodities markets occurs. Given we are over 10 years into a commodities bull run that is a big assumption to make, and these cycles tend to reverse for protracted periods of time. I will however put this on the watchlist and wait to see what happens with the order book, if it events change I will revisit the stock.

Disclosure: JOY – no position