Joy Global Reports Earnings, Caterpillar Investors Take Note

When a competitor's stock jumps 40% in a week, it's usually time to start looking at what's going on. Caterpillar's (NYSE:CAT) end markets include mining machinery, and Joy Global's (NYSE:JOY) recent surge must have had investors thinking Caterpillar could follow suit in due course. So let's take a look Joy Global's results and what they mean to the investment thesis for Caterpillar stock.

JOY data by YCharts.

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What Caterpillar's Sales Figures Tell You About the Economy

In case anyone was in any doubt as to the ongoing bifurcation in prospects between developed and emerging markets, then Caterpillar's  latest monthly sales data will make it clear. Moreover, based on Caterpillar's numbers, investors in the industrial sector should look closely at their stocks' exposure to various industries. As a consequence of what Caterpillar just reported, companies like Joy Global  can expect some varied conditions in the mining sector, and there was even some negative news for General Electric Company  in the power generation market. It's time to look more closely.



Caterpillar reports mixed construction trends
The company reports out of three separate industrial segments, and Fools already know that in its first-quarter results in April, Caterpillar upgraded its forecast for full-year construction machinery sales from 5% to 10%. At the same time, it downgraded its view on full-year resource industry sales from a negative to 10% to a negative 20%. Its energy and transportation guidance was left unchanged. Fast forward to the May sales data and a few themes are emerging.

First, there appears to be a strong divergence between Asia/Pacific and North America in terms of construction trends.

Source: Caterpillar presentations

In addition, according to a Bloomberg research report, China's fixed-asset investment continues to moderate from the torrid pace of growth in previous years.


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Stocks to Win the War on Coal

In another blow to the coal industry, the Environmental Protection Agency, recently announced rules demanding that power plants should reduce carbon emissions by 30% from 2005 levels by 2030. The likely effect of enacting these rules will be to damage prospects for U.S. coal miners, and with China increasingly concerned with reducing its dependence on coal, their (coal miners') export prospects could also be adversely affected in the future. With that said, it's time to look at which companies have upside and downside opportunities if the "war on coal" continues.



False dawn for coal mining?
You don't need to be Einstein to understand the importance of relativity, and the fact that Joy Global's    management recently predicted U.S. coal production would be incrementally positive this year is obviously a short-term positive.

However, it's far too early to conclude that coal has passed an inflexion point on the way to another multi-year expansion. For example, Caterpillar   recently lowered its forecast for full-year resource industry sales from a negative 10% to a negative 20%. Caterpillar's stock price is doing well this year, but it's more about the construction sector exceeding expectations and successful implementation of manufacturing cost reductions.



In addition, A quick look at U.S. coal production over the last 30 years demonstrates the demise of coal in recent years. Moreover, Fools should note that the extent of the period of decline since the last recession indicates that this isn't just an adjustment to a slowdown in global growth.

US Coal Production data by YCharts.

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Time to Buy Caterpillar and Joy Global?

The relative outperformance of Caterpillar  and Joy Global  in 2014 could easily lead Fools to conclude that the mining sector is making a comeback after a couple of years in the doldrums. Is this the case, or are their stock-specific reasons why these two companies have outperformed?

Caterpillar and Joy Global outperform
Going into 2014, the financial markets were fretting about the potential for emerging market weakness. Not only had a slew of companies reported growth that was less than expected in the BRICs, but fears over the shadow banking system in China, and subsequent defaults, have been at the forefront of concerns. It's usually true to say that if emerging markets catch a cold, then mining and commodities will start sneezing. Moreover, China's torrid pace of capital investment was bound to slow at some time, taking demand for certain hard commodities down with it.

These fears get expressed in the stock prices of mining capital-machinery companies, like Caterpillar and Joy Global. If conditions turn out to be not as bad as expected, then the stocks can see some upside, thanks to value hunters and "relief-rally" buyers coming in.

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Joy Global Earnings Analysis

Mining equipment company Joy Global (NYSE: JOY  ) gave results recently, but the real news wasn't so much about what the company said, it was about what the company didn't say. The earnings report was positively received by the market, and investors in competitors like Caterpillar (NYSE: CAT  ) took heart from some of Joy Global's commentary. On the other hand, most of the good news was stock specific, and the underlying end-demand drivers for mining machinery still look weak in 2014. So what exactly can Fools learn from the results?

What Joy Global said in its first-quarter results
The company raised the mid-point of guidance by issuing adjusted diluted EPS guidance of $3.10-$3.50 versus previous guidance of $3.00-$3.50. The bottom end of earnings guidance was raised, and management expects that margins will further improve in 2014.

 

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Caterpillar and Joy Global, Set for a Better Year?

It would be an understatement to say that mining had a difficult year in 2013, and it was even worse for the mining equipment suppliers like Joy Global (NYSE: JOY  ) and Caterpillar (NYSE: CAT  ) . However, investing is about what happens next, and the case for buying into the sector is based on the hope that mining companies' capital expenditure plans will improve in 2014. So, what do Foolish investors need to know before warming to the idea?

Mining capital equipment sales
The market took heart from Caterpillar's recent results, and this should be taken as a marker that the sector can go higher given any signs of a bottoming out in spending plans in the mining sector's spending plans.

 

READ THE FULL ARTICLE LINKED HERE

More Key Takeaways From GE's Report

Whenever General Electric  $GE gives results, the market tends to listen very closely. Its recent earnings report was broadly positive with orders up 8% and guidance of double-digit industrial earnings growth for 2014. However, a company of this size will never have all its industry sectors working well at any one time. In a previous article, its power and water, oil and gas, and lighting and appliances segments were looked at. Now it's time to look at its aviation, health care, and transportation units.

GE's profit split
In order to see the importance of its relative segments, here is a breakout GE's segments profits in 2013:

Source: Company presentations.

Of the four most important sectors, aviation and oil and gas put in the best performances in 2013. Power and water disappointed -- particularly in the first half -- but orders and revenue came back strongly in the second half. In the fourth quarter alone, power and water equipment orders were up 81%, and segment profits rose 9%. Meanwhile, its health care performance was relatively mundane with just 4.4% profit growth in the year.

Source: Company presentations.

GE's health care segment and Covidien
Despite its relatively mundane performance, GE's health care results are interesting because they highlight a bifurcation in global health care spending on capital machinery. Austerity measures and cash pressures are putting pressure on hospitals in developed markets, while emerging markets are more willing and able to spend. For example, in its fourth quarter, GE's health care orders were flat in the U.S., with Europe only up 2%. Meanwhile, Latin American orders were up 15%, with China up 8%.

These trends play to the strengths of a company like medical device company Covidien  $COV . The company's is characterized by having relatively low-ticket medical devices; something very attractive to emerging markets. Indeed, its growth prospects and investment plans are weighted toward emerging markets. Covidien grew sales to the BRICs by 25% in its last quarter, and it plans to generate at least 20% of its total sales from emerging markets by the end of 2014.  All told, Covidien has the potential to outgrow its markets.

GE's aviation segment
Aviation has been the star performer in GE's industrial segment, and for a host of reasons the commercial aerospace market has bright prospects in 2014. On the conference call, GE's management predicted that its jet engines "will be up to 2,500 units, versus about 2,378 in 2013", but the most interesting commentary was concerning its 16% rise commercial spares demand. In answering an analyst question on the subject, Immelt replied that flying hours were "improving dramatically", and airlines were restocking as they had cut back on inventory levels in 2012. Meanwhile airline fleets are growing and aging as well.

All told, this is great news for a company like Heico  $HEI . Heico generates two-thirds of its sales from its flight support group whose services include parts, repair and distribution for airlines. The segment put in a stellar performance in 2013 with sales and net income rising 17% for the full year. Moreover, it estimates overall sales growth of 12%-14% for 2014. If passenger demand remains strong and airline profitability continues to increase, then Heico is likely to have another strong year.

Mining still not globally joyful
In general, it was a positive report, however there were some notes of caution. Transportation segment orders were 2% lower, with mining being the main culprit. Mining orders declined 60% with demand for mining parts described as weak. All of which is not good news for mining equipment company Joy Global $JOY .

The mining industry has suffered this year as commodity prices have fallen, and in the words of Joy Global's executive vice president, Edward Doheny,  "[Years] of investment in additional production capacity finally caught up with demand. This resulted in most major commodities currently in a significant supply surplus".  The outlook doesn't look great. Growth is slowing in China and the government taking steps to reduce coal capacity; the outlook is still murky. Moreover, prices for a commodity like copper -- traditionally seen as the most cyclical of all metals -- continue to decline.

Copper LME Settlement Price data by YCharts

The bottom line
In conclusion, it was a broadly positive report from GE. Aviation and emerging market health care look strong in 2014, but developed market spending on health care capital equipment looks moderate at best. Meanwhile mining looks headed for another difficult year unless China can reaccelerate its growth rate.

Which Stocks to Buy IF China bounces

China remains one of the great imponderables in the investing world. Is it about to roll of a cliff or return to 10%-plus growth rates in the next few years? It's hard to answer these questions, but we do know that the Chinese government is determined to generate more growth in 2014. It's time to look at which sectors might benefit.

China to bounce back in 2014
By now, everyone will have realized that China's growth is slowing. Indeed, the 7.6% GDP growth target that economists have penciled in for 2013 represents the slowest growth in more than 14 years. Interestingly, the OECD predicts that China's growth will improve to 8.2% in 2014 thanks to a "small fiscal stimulus." Essentially, China has responded to slowing growth by initiating a round of stimulus spending, alongside measures to add liquidity into its system.

This time it's different
Old habits die hard, so whenever there's talk of China and spending, many investors simply go back to the mining and energy-based plays that worked so well in the last decade. However, it's different this time. Following its huge stimulus plan in 2008, China now has overcapacity in many heavy industries, including shipbuilding, solar energy, and cement and steel production. In addition, the government is trying to shift the Chinese economy away from its reliance on housing investment and exports (which are slowing anyway due to the current austerity in the West) and toward domestic consumption.

All told, these trends mean that the sectors likely to bounce in 2014 are not the ones we've seen skyrocket before. Indeed, the old commodity plays like Caterpillar and mining-equipment company Joy Global  have been under pressure this year. China's demand for base metals isn't what had been expected. In its latest quarterly earnings, released back in August, Joy Global reported orders down 28% on a constant-currency basis, with aftermarket bookings down 7%. Furthermore, increasing use of gas in the U.S. is holding back Joy Global's core coal market.

Aerospace and autos
However, there are areas of the industrial sector that are benefiting from this economic shift. For example, China's plans involve building 70 new airports in the next few years and expanding 100 existing airports. And if airports are built, routes usually follow. Indeed, a quick look at Boeing's  order book reveals that net orders of 1,054 (to the start of December) represents one of its strongest results in recent years. There is little doubt that Asia has been a major driver of order growth for Boeing. For example, according to the IATA, the Asia-Pacific region will generate 6.6% passenger traffic growth in 2014, compared to 5% in Europe and only 2.5% in North America.

In addition, Chinese car sales have bounced nicely in the second half of this year.

Source: China Association of Automobile Manufacturers.

All of this suggests that aerospace and automobiles will continue to benefit from China in 2014. In this regard, paintings and coatings company PPG Industries  is worth a look. PPG is heavily exposed to the automotive and aerospace sectors, and this year's acquisiton of the U.S. household paints division of Akzo Nobel is well-timed for the ongoing housing recovery.

A word of warning
All told, China looks capable of bouncing back in 2014, but investors need to focus on the long term. There is no guarantee that any stimulus measures or fiscal loosening will lead to tangible return on investment.

It may turn out that China's economy bounces slightly and then slips back again as these investments turn sour. The 2008 investment in industries like steel and shipbuilding could end up simply being mirrored with airports, roads, and transport infrastructure in 2014. Pause for thought.

Joy Global's Growth is Dependent On China Housing Market

China Construction holds the key to JoyGlobal Prospects?

Mining equipment company Joy Global gave results yesterday  and not only were they impressive, but the outlook statement was very positive too...

mining companies are realizing strong demand and prices, with the expectation of significant increases in demand during the next 3 to 5 years. As a result, they are making major increases in their capital expenditures for mine expansions. Mining companies have announced capital expenditures that are up 30 to 35 percent this year, and are approaching the levels of 2008. In addition, announced capital expenditures for 2011 are expected to rise another 15 to 20 percent.

..so everything looks rosy according to Joy Global's earnings release. With Joy Global and the likes of UK's Fenner, you have upside from a few strategic profit drivers.

Firstly, there is the resolution of economic growth and industrial capacity utilisation in the developed industrialised nations. This strengthens demand for commodities such as copper and coal.

Secondly, there is the secular trend towards shifting energy production towards using coal and away from oil. Not only is this a response to geopolitical risk with oil supplies but also it is reflective of the global shift towards manufacturing in the Far East. Coal is the major commodity that China is rich in.

Thirdly, there is the significant investment being planned in infrastructural projects within emerging markets. Many of these projects are pre-planned and committed and are essential for the long term growth of these countries.

Finally, there is the marginal demand from residential housing and construction in the World.

China's Construction Market is the Marginal Demand Driver

Of all of these profit drivers, I would view the key marginal  (housing and construction) as being the most important. My view is that Europe's banking sector will face more Sovereign Debt issues next year and this will cause some disruption to their recovery in the first half. Turning to the US, frankly, I don't think the US is in a position yet to see strong increases in new construction activity...

...and this is mainly due to the ongoing high vacancy rates

and also a result of a large number of foreclosed homes still waiting to come onto the marketplace.

So much depends upon whether China's property and construction markets are in a bubble or not?

China Property Market. An Asset Price Bubble?

Poetic symmetry seems to demand a bubble here. Japan had it, the US had it, the UK had it in the 90's and even Sweden had it in the 90's. Furthermore, with China you have a situation whereby currency manipulation (they are buying US Dollars and selling RMB) is flooding their internal markets with RMB which could be causing a local asset bubble. Throw in the extra stimulus efforts made by the Communist regime and you have all the ingredients for a bubble.

However, the tricky part here is to try and quantify the nature of the mass urbanisation movement within China. Jim Chanos claims that 60% of China's GDP is due to Fixed Asset Investment whilst only 5% is due to exports. You can see the importance of this kind of growth on global steel production here...


source: worldsteel

...and with so much of other emerging markets (Russia, Brazil) dependent on commodity exports to China, the knock on effect of a slump in China's property market is significant.

China Housing Vacancy Rates?

The problem that Chanos and others have is that there are no official figures for China's vacancy rates. However, we do know that according to the National Bureau of Statistics of China (NBSC)  Investment in Real Estate Development Enterprises is currently growing at a yearly rate of 34.2%

I do not think this is sustainable and also note that the Chinese are trying to deal with overheating in commodity prices and real estate, by successively raising banks reserve requirements. They may engineer a 'soft landing'. Who is to know? I'm sympathetic to Chanos' arguments on China and housing but the exact timing is hard to predict. Nevertheless, I do not think that now is the time to be meaningfully overt in this sector.




source:

Fortune Magazine "Chanos vs. China" (accessed Dec 2010)

NBSC "Investment Completed and Growth of Real Estate Development Enterprises"  (accessed Dec 2010)