Bullish Outlook for Mining Machinery Providers

By Dave Brown —Exclusive to Copper Investing News

Economists typically group macroeconomic statistics under one of three headings: leading, lagging or coincident.  Most often investors are content to make decisions based on coincident and lagging indicators providing some confirmation of the current context and past events, but establishing reliable economic correlations within a deluge of complex political and financial data is difficult.

In some cases emotional hunches can be just as significant as fundamental analyses for successful investment decisions.  Many industry observers and stakeholders will attempt to draw correlations from earnings results and company guidance as signs that could have broader implications or unintentional consequences.

A practical example

Last week, Caterpillar Inc. (NYSE:CAT) reaffirmed its 2011 guidance and increased its quarterly dividend by 2 cents to 46 cents to inflate shareholder value. The dividend increase represents a 5 percent boost. The company operates in three principal lines of business: machinery, engines, and financial products. Caterpillar is engaged in the manufacturing of mining and construction equipment, diesel and natural gas engines, industrial gas turbines, and diesel-electric locomotives. Caterpillar has been a consistent payer of quarterly dividends since its formation in 1925. The current dividend hike comes exactly after a year. The last dividend hike of 5 percent from 42 cents to 44 cents was announced on June 9, 2010; however, this followed a two year hiatus as the company had refrained from hiking dividends during the economic recession and maintained its dividend rate of 42 cents.

A case might be made that the demand for Caterpillar’s heavy equipment is on the rise given improving economic conditions, particularly in developing economies. The company’s strong brand name, global dealer network and pricing power create an advantageous position to exploit the growing need for infrastructure development worldwide.

Connecting the dots

In an exclusive interview with Copper Investing News, Adam Fleck Associate Director of Equity Research at Morningstar was more cautious in using this positive news flow to imply a broader trend, “The mining equipment sector is largely driven by mineral prices; high coal, copper, and iron prices typically drive increased mine expansion and construction, in turn leading to growing mining equipment orders. Certainly, I think sentiment is bullish right now. A glance at competitor Joy Global ‘s order growth over the past several quarters indicates heady demand, and mining customers are likely to increase capacity at a double-digit growth rate for the foreseeable future.”  He also noted the company’s bullish strategy anticipating that the global economy will continue to grow at a solid pace, led by emerging economies.  Although the company remains optimistic, Mr. Fleck cautioned, “I actually tend to be a little more cautious on China, given the government’s attempts to control inflation, but I don’t think we’re about to slip into another worldwide recession. Again, Caterpillar’s revenue and profit growth is indicative of much better performance in the first quarter from the year prior, but I ‘ m not sure that it correlates directly with the overall global recovery or is a leading indicator of such.”

Competitive balance

A peer competitor for Caterpillar, Deere & Co. (NYSE:DE) increased its dividend by 17 percent on May 24. Caterpillar’s current annualized dividend yield of 1.9 percent falls slightly behind Deere’s annualized dividend yield of 2.1 percent; however, Caterpillar’s dividend payout ratio of 29.9 percent is higher than Deere’s 22.0 percent.

Deere has also announced plans to build a factory to manufacture engines for equipment built in China for a total investment of $60 million and is expected to start production in late 2013.  This will be Deere’s sixth engine factory worldwide adding to the list of engine factories in Argentina, France, India, Mexico, and the United States. These factories are strategically located to support facilities that manufacture John Deere’s equipment on the global scale.

Joy Global Inc. (NASDAQ:JOYG) offers a second competitive example of a manufacturer of mining equipment for the extraction of various minerals and ores. The company’s equipment is used in mining regions throughout the world to mine coal, copper, iron ore, oil sands and other minerals.

Last week the company reported strong earnings but tempered future guidance, “Copper fundamentals are among the strongest of all commodities. Demand has broadened with recovery in the industrial sector of the developed economies, but China remains the major consumer of global demand. China copper imports have slowed this year, but inventories at the Shanghai Futures Exchange have dropped by half, which indicates that China is going through another cycle of de-stocking. “