One key trait that separates developed economies (such as the U.S., Canada, Europe and Japan) from emerging economies is the relative swings in GDP. While developed economies are so mature that they grow or shrink in a glacial fashion, emerging economies are much more dynamic, with booms and busts arriving seemingly every decade.
And for emerging-market economies that focus on commodities, the cyclical swings can be even more profound. Firm commodity prices (as we saw in the middle of the past decade and again just a few years ago) lead to huge spikes in orders for mining equipment. And a huge drop in these economies — and the price of the commodities they produce — can lead to real pain for the companies that serve them.
Many investors got out of JOY long before the cloudy sales picture emerged. Although the company was poised to deliver solid results in 2012, it seems investors concluded that the still-weak global economy would eventually pressure the company’s sales outlook.
When it comes to a deeply cyclical stock like JOY, traders can score solid gains when pessimism is at its peak, as its stock valuation comes down to levels that sharply discount better days ahead.
To understand why farsighted investors should be looking at this stock now, you need to look at the reinvestment rate among miners, which compares capital expenditures (capex) with earnings before interest, taxes, depreciation and amortization (EBITDA).
Mining equipment is used in harsh environments and, as a result, needs to be replaced fairly often. Generally speaking, mining firms tend to spend roughly 50% of EBITDA on capital equipment, according to Goldman Sachs Group, Inc. (NYSE:GS). That’s a 10-year average figure, though it slumped to 40% in 2010 while the global economy struggled to emerge from a deep slowdown that began in 2008.
But the recent sharp slump in commodity prices has led mining firms to become especially cautious as major mining projects get squeezed to generate as much cash flow as possible. As a result, Goldman Sachs looked at Joy Global’s 2014 order book and concluded that the capex-to-EBITDA reinvestment rate for its client base is now down to just 29%, an almost unheard-of level. That explains why revenue for the coming year is expected to decline by more than a billion dollars.
As for the stock, it has lost more than $3 billion in market value since the start of 2011, thanks to that investor exodus.
2009 Redux?
JOY has seen this scenario play out before. In 2008, customers began canceling orders, and orders (and sales) didn’t pick up much in 2009 or 2010. But farsighted investors knew that the company would eventually see its clients play catch-up by placing new orders. For the more nearsighted, by the time that trend was fully in evidence, they had missed the major move in this stock.
