We are all familiar with the old saying, "You get what you pay for," and in this case, that is exactly what we are counting on.We believe buy-and-hold investors could be well rewarded for taking an early interest in the mining-equipment manufacturer and services provider Joy Global ( JOY). Shares of Joy Global closed Tuesday's trading at $55.57. Joy is not expensive when looking at its price-to-earnings ratio, as it currently trades at about 8x consensus fiscal 2013 earnings expectations of $6.73. This is well below its historical (past five years) price-to-earnings ratio of 14x. The stock deserves its low multiple today. You can make money on this stock in two ways. As the Chinese economy, the domestic economy and the global economy improve (in that order of importance), we expect Joy's stock price to appreciate, as the company's earnings should grow at a faster rate, making the earnings rise (and the E in the P/E multiple increase). We also expect the multiple at which the stock trades to approach historical norms (meaning the multiplier would increase as well). Given the right conditions, Joy Global offers robust upside. Joy Global is a worldwide leader in high-productivity mining. The company manufactures and markets original equipment and aftermarket parts and services for the mining industries through both its surface and underground mining business units. Coal as an end-market represents about 75% of sales for Joy Global. Investors have correctly tied the company's near-term fortunes to the strength of economic growth out of China. China is the world's largest consumer of electricity, and in both China and India, coal continues to be the commodity of choice to fuel electricity plants. As China goes, so goes Joy Global. China produces more than 50% of the world's coal. Even though China accounts for only about 11% of Joy's sales, the company's other regions are helped or hindered by the strength (or lack thereof) of the economy in China. Interestingly, China accounts for 63% of the worldwide coal-fired power capacity that is either planned or under construction, and India represents 20%. This is why Joy Global is expecting its revenue from China to double by 2017 and why it points to a resumption of demand. The question of a rebound related to Joy's stock is a matter of when, not if.
Joy Global's management knows that markets are slowing, and indeed, it is preparing for negative growth in revenue and earnings in 2013. The company is rapidly cutting costs and seeking operating efficiencies to absorb some of the weakness. The company is set to maintain its robust margins even in times of strain, and a key component is the company's aftermarket parts and services business, which accounts for about 60% of revenue. The servicing of deployed equipment provides Joy with a steady revenue stream, robust margins and significant visibility. In recent years, Joy has been acquisitive as it seeks to bulk up to compete with global giants including Caterpillar ( CAT). The company's acquisition of International Mining Machinery Holdings is a key to opening additional opportunities, since that is one of China's domestic producers of mining machinery. After recent acquisitions, Joy's debt-to-capital ratio popped to about 40%. Management said it expect the business to generate $4 billion of free cash flow between 2012 and 2017, which can be used to pay down debt, repurchase shares or make additional acquisitions. The stock currently sports a 1.3% dividend yield. Just this past weekend, China's purchasing managers' index came in line with expectations at 50.6. More importantly, this was the second consecutive month above the 50 level, which indicates expansion. The number is at a seven-month high, with the best output since July, solid growth in new export orders and a pickup in purchasing activity. The official PMI of non-manufacturing sectors also improved to 55.6 in November, led by expansion in construction and partially offset by slower air, rail, food and beverages. These data, along with stronger retail sales, exports and services, all point to a soft landing in China and the possibility for 8% GDP growth in the fourth quarter. Our bottom line: Joy is a high-quality, well-positioned and well-managed company that is being extremely attentive to managing its costs in times of tightness. This should set up the company for lots of operating leverage when the global economy picks up.