Kwame Webb: We believe Joy Global (JOY) is a compelling investment opportunity for patient investors. Joy is one of the world's largest mining-equipment manufacturers. Its products extract minerals with stable demand patterns like thermal coal but also more economically sensitive commodities like copper and iron ore. With growing concern around China's demand for these commodities as well as a declining global preference for coal-fired power generation, the company's share price has declined more than 60%, year to date. We expect more near-term demand weakness from China; however, we expect more benign demand patterns for thermal coal, with India and Southeast Asia remaining focal points for incremental demand growth.
While we share the market's concerns about near-term demand weakness, the recent share-price decline has pushed the stock to roughly seven times our free cash flow estimate and a 60% discount to our fair value estimate. Further, we like the name in spite of the difficult outlook because Joy garners 75% of revenue from relatively sticky aftermarket services and repairs. With Joy's products often in service for 30 or more years, customers face a very high switching cost if they turn away from Joy, and this customer entrenchment is the primary source of Joy's narrow moat rating.
Joy isn't solely a victim of a tough outlook. To improve margins, it is consolidating its manufacturing footprint with expectations that these efforts will raise factory utilization from the current 55% level to 75% by the end of 2017. The company is also deploying free cash flow to diversify into the more fragmented hard-rock mining equipment. As these initiatives begin to positively impact results during the next two years, shares present a significant opportunity for share-price appreciation.