Joy Global’s Wall of Worry

06/01/2012 4:25 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

The long-term trend is still exceptionally strong for the mining-equipment maker, but it’s been beaten down of late. MoneyShow’ Jim Jubak, also of Jubak’s Picks, suggests keeping a close eye.

Are we all market timers now?

What makes me wonder? My reaction to Joy Global’s (JOY) second-quarter earnings report yesterday, May 31, before the New York markets opened. The company beat Wall Street projections by 8 cents a share on earnings and reported a 45% year-to-year gain in revenue to $1.54 billion (above the $1.43 billion consensus among analysts).

But the stock got savaged when the company lowered its guidance for fiscal 2012 to $7.15 to $7.45 a share from the prior guidance of $7.40 to $7.80 a share. Before that revision, the Wall Street consensus had been $7.64 a share in earnings for fiscal 2012.

The stock closed the day at $55.86, near the bottom of its 12-month range of $53.26 to $101.44 a share. The stock is down 34% in the last year and 41% from its February 3 closing high at $95.23.

The shares are well below the 50-day moving average at $68.71 and the 200-day moving average at $77.92. In fact, they’re pretty much back to where they were at the October 2011 low before the stunning end-of-the-year rally that extended into the first two months of 2012.

Did I rush to buy on the bad news? Nope. My first reaction was that I should wait for the shares to move lower. They were cheap today. But they’d probably be cheaper tomorrow.

That’s a totally understandable reaction to the current market environment, where:

  • stocks seem to move lower every day on a steady diet of bad news from Europe, China, Brazil, and the United States
  • a horrible May has pretty much wiped out all the gains from the first two months of the year for stock indexes in the United States
  • and it’s hard to find a silver lining in any of the gray clouds that still crowd the horizon

But while the reaction is understandable, I’m not sure it’s the correct one. We know from work in the last few decades in behavioral finance that investors have a roughly 2:1 preference for avoiding losses to acquiring gains even at the best of times. And this certainly isn’t the best of times.

Recently we’ve all taken losses on “good” stocks so that pulling the trigger on anything has become incredibly difficult. Better, our emotions and recent experience tell us, to wait until prices are lower tomorrow. At least that way we won’t suffer another loss.

So is the long-term case that I can make for owning Joy Global relevant at all to a buy/sell/hold decision now? (Joy Global is a member of my Jubak Picks 50 long-term portfolio.)

To decide, I’d start first with what the company said in its conference call when it lowered guidance for fiscal 2012. The company sees weakness in markets around the world. The US market is soft. Growth in the Eurozone has slowed. China’s economy looks to be slowing. All this slowing is expected to reduce earnings by 18 cents a share in fiscal 2012.

At least that’s the way things look now—they could get worse because uncertainty is so high, the company noted. The US coal market is coping not just with weakness in global economies, but also with increased competition from cheap natural gas in the United States. That has reduced production and revenue at mining companies—leading to a slowdown in orders.

But the company expects that this market will stabilize by the end of the year. In China, Joy Global said it expects the economic slowdown to bottom in the near term, and that its markets there will return to growth due to increased government spending.

 Investors have heard this before from many companies, of course, and we’re entitled to be skeptical about predictions for a turn in the company’s markets. The company admitted as much in its conference call, saying that they don’t know whether the upside will appear in the near or longer term.

Second, I’d look at the Wall Street reaction to the news. This uncertainty has left Wall Street target prices all over the map. For example, after the guidance from the company, Barclays cut its target price to $88 from $96. UBS, however, cut its target to $58 from $78.

And third, I’d look at whether any of this changes the long-term positive trend for Joy Global. I think here, the answer is no.

World demand for mined commodities will increase over the long-term and the need to buy more mining equipment to expand mine capacity and production is intact. I’d even argue that any orders lost in the current slowdown aren’t so much lost as delayed.

The average age of an electric shovel used in mining is now more than 16 years. At some point, aging equipment has to be replaced, and I think Joy Global is looking at the same kind of deferred demand that powered revenue and earnings growth at Cummins (CMI) once truck owners decided to upgrade their aging fleets.

My conclusion: I would like to own Joy Global for the long-term, and so far the short-term hiccups haven’t really changed the long-term story. But experience tells me that once a Wall Street favorite has hit a soft patch like this, the stock is likely to go through a period of further weakness as Wall Street analysts cut their target prices to catch up with the current share price.

I’d wait on Joy Global for a while, watching out for when analysts stop cutting their target prices by $20 at a pop, and for when the spread among analysts isn’t quite so extreme.

I’d put this one on my watch list for a few months at this point.

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund, may or may not now own positions in any stock mentioned in this post. The fund did own shares of Polypore International as of the end of September. For a full list of the stocks in the fund as of the end of September see the fund’s portfolio here.

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