Caterpillar or Joy Global: Which Should You Dig Into?

by Will Ashworth | November 3, 2011 10:24 am

The farm and construction equipment industry had a strong October, with both Caterpillar (NYSE:CAT[1]) and Joy Global (NASDAQ:JOYG[2]) achieving gains in October that were higher than the S&P 500, which was up 10.9%. Caterpillar was up 24.7% and Joy Global 39.8%. Year-to-date, however, they’re both in negative territory, about equal with the index. Still, both are heating up — so which one should investors flock toward?

Analyst Consensus

First, let’s take a look at Caterpillar. Its third-quarter report was exceptional, delivering record profits and revenues. Earnings per share beat the consensus estimate by 21%. According to Caterpillar, its backlog in the quarter was higher than it’s ever been, and this prompted analysts to up their guidance for 2011 and 2012. Analysts are calling for 2012 EPS of $9.04 per share. If CAT hits its 2011 estimate of $6.85, that will mean earnings growth of 32% next year. It’s hard to bet against that.

As for Joy Global, it expects revenues and earnings per-share for fiscal 2011 of at least $4.3 billion and $5.70 per share. Its backlog as of the end of the third quarter was $3.2 billion — substantially higher than the $1.82 billion in fiscal 2010. The primary reason for this growth continues to be the success of the mining business in general.

Joy Global’s year-end is Oct. 31, whereas Caterpillar’s ends on Dec. 31, so annual estimates don’t compare perfectly but nonetheless are helpful to look at. Joy Global’s fiscal 2012 earnings estimate is $7.20 per share. The 2011 estimate is $5.93, which is the high end of the company’s guidance as of the end of the third quarter. Joy Global has delivered positive earnings surprises in three of the past four quarters. Assuming JOYG earnings hit $5.93 per share, next year’s earnings growth will be approximately 21% year-over-year. Not quite as high as Caterpillar, but very reasonable.

Direct Competition

Caterpillar and Joy Global became much closer competitors in July when Caterpillar completed its $8.8 billion purchase of Bucyrus International, a manufacturer of high-productivity mining equipment for the surface and underground mining industries. That’s Joy Global’s bread and butter. At the end of 2010, Caterpillar’s mining revenues were 11% of overall revenue compared to 100% for Joy Global.

Now, you might think that placing all your bets on one industry is risky, but when you have a mining sector that continues to grow around the world, not to mention consolidate at the same time, it’s a very appealing business to be in, hence Caterpillar’s almost $9 billion acquisition.

When it was announced back in November 2010, Caterpillar suggested Bucyrus would add $2 billion in revenue for 2011. That’s more than four times sales, which I guess is worth it considering the move vaults it past Joy Global on the mining front, not to mention acquiring one of the oldest companies in the industry. We will see if its decision to retire the Bucyrus name in favor of Big Yellow was a good one.

Valuation

This is where the decision becomes an easy one. Caterpillar’s acquisition puts a floor price on Joy Global’s stock. How so? It was willing to pay a premium to acquire a direct competitor to itself and Joy Global. Caterpillar acquired Bucyrus to be first in line as mining producers join together. It’s a lot like musical chairs in that only so many manufacturers of mining equipment will continue to have keys to the kingdom.

But in doing so, Caterpillar inadvertently has turned JOYG into a value play of sorts. Joy Global stock currently trades for a little more than two times sales. Someone will come along willing to pay the same multiple, especially when Caterpillar already took out one of the biggest players in the mining business. Call it the price of admission. On the other hand, despite the fact CAT trades at slightly more than one times sales, it doesn’t mean someone will come along and pay more for it. Caterpillar has an enterprise value 10 times that of Joy Global. There aren’t too many companies that can digest this big a purchase, so it doesn’t face the same upward pressure on its stock.

Bottom Line

When you consider that Caterpillar has total debt three times EBITDA compared to one times EBITDA for Joy Global, it’s relatively easy to recommend investors sell CAT and buy JOYG, especially if you’re looking for a pure-play manufacturer of mining equipment.

As of this writing, Will Ashworth did not own a position in any of the stocks named here.

Will Ashworth has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia.

Endnotes:

  1. CAT: http://studio-5.financialcontent.com/investplace/quote?Symbol=CAT
  2. JOYG: http://studio-5.financialcontent.com/investplace/quote?Symbol=JOYG

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