2015 was not kind to mining equipment makerJoy Global -- or to Caterpillar , either. Over the course of 12 long, hard months, Joy Global shares lost 74% of their value. More diversified Caterpillar stock still suffered a 26% decline in market capitalization. (Yes, that adds up to 100% -- but it's just a coincidence.)
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At least one analyst, however, believes that 2016 is shaping up to be a much better year for both of these commodities industry suppliers.
Bright and early Monday morning, Goldman Sachs sounded a cheerful note on the future for both Joy Global and Caterpillar stock, removing sell ratings previously attached to each security, and upgrading both to neutral. Why not buy?
Well, for one thing, the prices aren't quite right. Priced at roughly $21 per share today, StreetInsider.com quotes Goldman as predicting Joy Global shares will rise only a few bucks to $24 by year end. Caterpillar, which Goldman Sachs says is worth $78 a share...costs more than $78 today. And yet, Goldman Sachs is still clearly optimistic about both stocks.
Why? Three reasons.
A truckload of profits from CAT stock? Maybe. But there's a big reason to be cautious. Image source: Caterpillar.
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Reason No. 1: China
"The breadth of the China construction recovery is broadening," says Goldman Sachs. And "with mining equipment share of total capex budgets at trough," Goldman thinks there's nowhere to go but up from here.
By Goldman's estimation, capital spending on mining equipment in China is currently "50% below normalized," and in a cyclical industry like machinery (and commodities, and machinery that mines commodities), Goldman expects to see Joy Global's fortunes, and Caterpillar's as well, improve as early as 2017.
With 100% growth needed to return to normal, there's a lot of room to rise.
Reason No. 2: Also China
Goldman estimates that China accounts for about 36% of direct sales of "commodity machinery" globally.
Now, that doesn't mean that Joy Global and China get 36% of their sales from China. (In fact, according to data from S&P Global Market Intelligence, Caterpillar only does about 19% of its business in the Asia-Pacific region, while Joy Global's Chinese sales were less than 12% of total sales the last time this information was broken out.) Still, China is a big part of both companies' business.
Reason No. 3: You guessed it -- China
And because China doesn't just produce its own commodities, but is a big importer from abroad, direct sales are also only part of the picture. Goldman estimates "commodity export countries" make up 20% of the market, and S&P Global data confirms that Australia alone, for example, produces 15% of Joy Global's revenues.
A revival of Chinese demand for commodities such as coal and iron would therefore likely boost sales of mining equipment to countries that feed China's demand for these commodities.
The most important thing
All that being said, and as bullish as Goldman Sachs is on Chinese growth (where spot iron ore prices have grown 20%since February), the analyst still isn't recommending that you buy either Joy Global or Caterpillar -- and that's another important point in this story.
China aside, Goldman worries that "Machinery end markets in the Americas (63% of sales) ... are over-supplied." S&P Global data show North and South America accounting for nearly 57% of Caterpillar's business. Joy Global, too, is heavily dependent on the state of American mining, deriving 32% of revenuefrom here at home. Without the prospect of growing sales in an oversupplied home market, there's a ceiling on how fast either company can grow in the short term.
Meanwhile, Goldman notes that valuations "are at the high end of the historical range" for both Joy and Cat. Currently, Joy Global shares are unprofitable and trading for more than 47 times next year's projected profits. Caterpillar shares look a bit more reasonable, selling for a 22 P/E today, and for 22.2 times forward earnings. On the other hand, most analysts still see Caterpillar growing earnings at less than 1% annually for the foreseeable future. That's pretty miserly growth to be paying 22 times earnings for.
So long story short? Goldman Sachs finds the China story encouraging enough to remove its sell rating on Joy Global and Caterpillar stock. Me, I'm not convinced they don't have farther to fall.
The article Joy Global and Caterpillar Stock Upgraded: 3 Reasons to Buy the Hype originally appeared on Fool.com.
Fool contributorRich Smithdoes not own shares of, nor is he short, any company named above. You can find him onMotley Fool CAPS, publicly pontificating under the handleTMFDitty, where he's currently ranked No. 297 out of more than 75,000 rated members.The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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