Streetwise

Lauren Rudd

Sunday, August 8, 2010

Two Companies That Defy Economic Doom

Although Wall Street has been volatile of late, it has also been quite bullish with regard to the future outlook for corporate earnings. This is undoubtedly a disappointment for those whose shrieks of impending doom and a Dow of 1,000 are a heady call to arms.

While the battle cries of disastrous deficits, failed stimulus programs and rising inflation ring hollow when bathed in the light of reality, hysterical voices continue to flood the media. The message, repeated ad nauseauum, is that we cannot afford the unemployed, the poor, healthcare, Medicare and Social Security. Drastically reducing deficits and debt must take precedence, aided by extending the Bush tax cuts. Failure to act will topple Wall Street and the economy the bastions of conservatism tell us.

It is true that the stimulus programs accounted for 15 percent of the deficit in 2009, 28 percent in 2010 and 14 percent in 2011. However, economists Alan Blinder of Princeton University and Mark Zandi of Moody’s Analytics, recently delineated the specific benefits of those programs.

According to their in-depth econometric analysis, the fiscal stimulus programs added 3.4 percent to real GDP in 2010, reduced potential unemployment by about 1.5 percentage points, while adding almost 2.7 million jobs.

Unfortunately, we are far from being out of the woods. A once unthinkable level of unemployment could easily become the norm. Instead of solving the problem, many in Congress want to declare high unemployment a structural and permanent part of the economic landscape — thereby condemning the unfortunate to the horrors of poverty.

The tragic part is that relatively simple solutions are readily at hand. Yale economist Robert Shiller pointed out that the government could hire workers directly for public services, just as it did during the Great Depression. For example, $30 billion could employ a million people at $30,000 each, equating to about 0.2 percent of the national debt.

So why should you care about adding stimulus programs and reducing unemployment? The answer is easy; they bring about increased economic activity, rising corporate profits and subsequently higher corporate share prices.

Consider for example Bucyrus International (BUCY) and Joy Global (JOYG), two companies I talked about for the first time last year, both of whom have benefited, and will continue to benefit, from the ongoing economic expansion.

Bucyrus engages in the design and manufacture of mining equipment for the extraction of minerals worldwide. A year ago my 2009 earnings estimate for the company was $3.65 per share with a 12-month target price of $36. The company earned $4.12 per share and the shares recently closed at $63.54, for a one-year capital gain of 75 percent.

Joy Global also engages in the manufacture and servicing of mining equipment for mineral extraction of worldwide. A year ago my 2009 earnings estimate was $4.00 per share with a 12-month target price of $44. The company earned $4.41 and the shares recently closed at $60.61, for a one-year capital gain of 36.4 percent.

Past history is all well and good. However, what counts is the future outlook for the two companies. Bucyrus has an intrinsic value of $103, using a discounted earnings model, with an earnings growth rate of 16 percent and a discount rate of 15 percent. The more conservative free cash flow to the firm model yields an intrinsic value of $90. My 2010 earnings estimate for Bucyrus is $4.32 per share with a 12-month target price on the shares of $74.

The intrinsic value of Joy’s shares, using the discounted earnings approach with an earnings growth rate of 12 percent and a discount rate of 15 percent, is $98. The free cash flow to the firm model yields an intrinsic value of $78. My 2010 earnings estimate for Joy is $4.20 per share with a 12-month target price on the shares of $68.