Streetwise for Sunday August 23, 2009

Streetwise

Lauren Rudd

Sunday, August 23, 2009

Forget Inflation and Look to Stock Ideas

It is probably a great disappointment to those for whom the heralded cry of impending doom has been the banner under which they have marched for so long, but the various stimulus programs appear to be working. More importantly, the much espoused inflation genie continues to remain in absentia.

Looking at the most recent numbers, the consumer price index was flat in July as compared to June, with a 12 month decline of 2.1 percent, the largest drop since 1950. If you remove the volatile food and energy sectors, the so-called core rate was up only 0.1 percent in July.

On a wholesale basis, the producer price index for July fell 0.9 percent, while the core rate fell 0.1 percent. Over the past 12 months, the prices of goods before they reach store shelves fell 6.8 percent.

Furthermore, inflation fighting productivity continues to grow. Nonfarm productivity rose 6.4 percent in the second quarter, while manufacturing productivity was up 5.3 percent. So where am I going with all these statistics?

The answer is easy, I am simply pointing out the field has been tilled, the seeds planted and the Fed is watering and fertilizing with cash. The resultant economic growth, which has already begun, will move us to a more normal self-perpetuating environment, at which time the Fed will remove the excess cash from the system, just as you turn off the hose when you are done watering. 

Increased economic activity brings with it rising corporate profits and subsequently rising share prices. Two companies that have and will continue to benefit from the ongoing economic expansion are Bucyrus International (BUCY) and Joy Global (JOYG), two companies never before mentioned here.

Bucyrus engages in the design and manufacture of mining equipment for the extraction of coal, copper, oil sands, iron ore, and other minerals in mining centers worldwide. For the second quarter ended June 30 net income was $1.08 per share, as compared to $0.83 a year ago. Revenue increased 17 percent to $724.4 million.

A discounted earnings model, with an earnings growth rate of 12 percent and a discount rate of 15 percent, yields an intrinsic value of $59. A free cash flow to the firm model yields a value of $80. The shares recently closed at $31.37.

Joy Global also engages in the manufacture and servicing of mining equipment for the extraction of coal, minerals and ores worldwide. Second quarter ended April 30 results showed net income of $1.17 per share, as compared to $0.66 a year ago. Sales for the quarter increased 10 percent to $924 million.

The intrinsic value of Joy’s shares using the discounted earnings approach, with an earnings growth rate of 8.5 percent and a discount rate of 15 percent, is $53. The free cash flow to the firm model yields an intrinsic value of $63. The shares recently closed at $39.35.

My 2009 earnings estimate for Bucyrus is $3.65 per share with a 12-month target price of $36, while for Joy it is $4.00 per share with a 12-month target price of $44. There is currently a 0.30 percent dividend yield with Bucyrus, while Joy offers a dividend yield of 1.70 percent.

I am not alone in my opinion of these two companies. Goldman Sachs analyst Jerry Revich recently wrote to clients that Bucyrus and Joy Global have strong exposure to rising demand in emerging markets. He reiterated a "Buy" rating on both companies.

Furthermore, Goldman’s coal analysts believe cash flow at mining companies will rise between 10 percent and 15 percent from 2010 to 2013, which Revich said should drive capital spending up by 15 to 20 percent for investment in equipment such as that made by Bucyrus and Joy.